Payroll Taxes Explained

The difference between what you expect to get paid and what actually lands in your bank account can be, well, surprising. A chunk of this difference goes toward payroll taxes. Like the name implies, payroll taxes are taxes taken out of your wages and paid to the government.

What’s Taken Out

Unlike health insurance or retirement contributions that you choose to deduct from your paychecks, you don’t get to choose whether to pay taxes or not. Taxes deducted from your income include:

• Social Security contributions (6.2%)
• Medicare contributions (1.45%)
• Federal income tax
• State taxes
• Municipal taxes

Your pay stub details exactly how much you contribute to each of these categories per paycheck and likely shows a running annual total.

FICA Taxes

Contributions to Social Security and Medicare—referred to as Federal Insurance Contributions Act, or FICA taxes—are set at 6.2% and 1.45% of your salary, respectively. There are Social Security caps at certain income levels. In 2024, the income cap is $168,600—any wages or salary earned over that amount are not subject to taxation. Medicare doesn’t have a cap, but if you make more than $200,000, you’ll pay an additional 0.9%. Because everyone making the same salary pays the same amount of FICA, it’s considered a regressive tax.

Federal Income Tax

The percentage of your income deducted for federal income tax depends on your withholdings, as dictated on tax form W4. Factors include your filing status, number of exemptions, and your salary. If you opt for more exemptions, more money is withheld from your taxes, decreasing the chances that you’ll owe money come tax season. If you opt for fewer exemptions, less money is withheld, and there is a chance you’ll need to pay more when filing a return. You can make changes to form W4 at any time; check your online HR portal, if you have one, or reach out to HR for details on how to make changes.

State and Municipal Taxes

The amount of state and municipal taxes deducted vary widely. Nine states don’t levy state income taxes at all—Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Likewise, municipal taxes vary. Income taxes are progressive, so those who make more are taxed at a higher rate.

What It’s Used For

The money you pay into Social Security and Medicare builds “credits” with the Social Security Administration that are necessary to qualify for these benefits after you retire. To receive full Social Security benefits come retirement, you need 40 credits. You can earn up to 4 credits per year, based on your total wages for the year, so you need roughly 10 years of full-time work to hit this target.

Your Social Security taxes go into a government-managed trust fund with the U.S. Treasury for old age and survivors insurance, and for disability insurance. Medicare taxes go toward Medicaid funds designed to provide affordable health care in retirement.

Income taxes deducted from your paycheck go straight to the U.S. treasury. If you overpaid, you’ll receive the surplus back as a refund when you file a tax return. Federal taxes are used for a huge range of purposes—mainly national programs like defense, veteran and foreign affairs, social programs, community development, law enforcement, and interest on the national debt.

State taxes go to the state treasury. If you overpaid in state taxes, you’ll get a refund, too. State taxes are used to support transportation, corrections, economic development, parks and recreation, aid to local governments, and other services. The largest areas of state spending nationwide are public education and health care.

Even though you never “see” a large portion of your payroll deductions, you still benefit from paying them. You’ll reap the fruits of your Social Security and Medicaid contributions down the road, and federal and state taxes contribute to services you likely use all the time.