Payroll Tax: FICA, Social Security & Medicare Explained

Payroll taxes are taxes imposed on employers and employees based on wages and salaries. They are the second-largest source of federal revenue after individual income taxes and primarily fund Social Security, Medicare, and unemployment insurance programs. Unlike income taxes, payroll taxes are generally flat-rate taxes applied to wages up to certain thresholds.

The most significant payroll tax is FICA (Federal Insurance Contributions Act), which combines Social Security tax (6.2% each from employer and employee) and Medicare tax (1.45% each). Together, FICA represents a 15.3% combined tax on wages, split evenly between employers and employees. Additionally, the Federal Unemployment Tax Act (FUTA) imposes a 6.0% tax on employers on the first $7,000 of each employee wages, though credits for state unemployment taxes typically reduce this to 0.6%.

For most workers, payroll taxes are automatically withheld from their paychecks and matched by their employer. This means the cost of payroll taxes is largely invisible to employees, who see only their half of the deduction. Self-employed individuals pay both halves through the self-employment tax, making payroll taxes a more visible and significant expense for freelancers and business owners.

How It Works

Employers are responsible for withholding the employee share of FICA taxes from each paycheck and remitting both the employee and employer portions to the IRS. The withholding is based on gross wages before any deductions for retirement plans, health insurance, or other benefits. However, contributions to certain pre-tax benefit plans can reduce the wages subject to FICA.

Social Security tax applies to wages up to the annual wage base ($176,100 for 2025). Once an employee earnings exceed this threshold, no additional Social Security tax is withheld for the remainder of the year. Medicare tax has no wage base limit and applies to all wages. Additionally, employees earning more than $200,000 are subject to an Additional Medicare Tax of 0.9%, which is withheld by the employer but not matched.

Employers must deposit payroll taxes on either a monthly or semi-weekly schedule based on their total tax liability, and report them quarterly on Form 941. Annual reporting is done on Form W-2 for each employee and Form W-3 as a summary transmittal. Failure to properly withhold, deposit, or report payroll taxes can result in significant penalties, and responsible persons can face personal liability through the Trust Fund Recovery Penalty.