The United States uses a pay-as-you-go tax system, which means you must pay income and payroll taxes as you earn income. For employees, these taxes are typically withheld from each paycheck by their employer. Income tax is assessed against your modified adjusted gross income, including bonuses, whereas payroll taxes are additional assessments earmarked specifically to pay for Social Security and Medicare.
Payroll Tax Vs. Income Tax
The U.S. income tax rates are graduated, meaning that higher-income individuals and couples are assigned a higher tax bracket, which is the marginal tax on the last dollar of taxable income you earn for the year. As of 2018, the federal income tax has seven rates ranging from 10 percent to 37 percent, as specified in the Instructions for Form 1040. Payroll taxes are flat rather than graduated, and are used exclusively to fund the Social Security and Medicare trust funds. However, your income can influence how much payroll tax you pay.
Paying Social Security Tax
The Social Security component of the payroll tax is set at 12.4 percent of taxable income as of 2018. The tax is shared by employer and employee, who each pay 6.2 percent. The tax is used to pay for federal old-age, disability and survivors’ insurance. It is withheld by your employer and reported separately from the Medicare tax on your pay stub. Social Security tax is collected on the first $128,400 of employee wages, known as the wage base. Income above the wage base is not subject to Social Security tax.
Paying Medicare Tax
The Medicare portion of the payroll tax pays for hospital insurance under the federal Medicare system. The tax rate as of 2018 is 2.9 percent, of which you and your employer each pay 1.45 percent. There is no wage base limitation on Medicare tax. However, there is an additional Medicare tax of 0.9 percent withheld on annual employee compensation exceeding $200,000. You alone pay the additional tax, as it is not imposed upon your employer. The additional Medicare tax withholding begins in the pay period when your compensation exceeds the $200,000 threshold.
You may owe a different amount of Medicare tax than that withheld from your paycheck. For married couples filing jointly, the Medicare additional tax threshold is $250,000. In addition, self-employment income and railroad retirement compensation must be included when calculating whether your income has exceeded the additional tax threshold.
Paying Taxes as Self-Employed
If you run your own business or are otherwise self-employed, you must pay estimated income and payroll taxes in lieu of withholding. Estimated payments are due on the 15th of April, June, September and January. In general, your estimated income tax payments must equal 90 percent of your total expected tax for the current tax year or 100 percent of the total tax shown on your previous year’s tax return. In addition, you must make estimated payroll tax payments for the employer and employee portions of the Social Security and Medicare taxes. You are also subject to the additional Medicare tax on income above $200,000. You can take a payroll tax income tax deduction on the employer portion of payroll taxes when computing your self-employed income tax. Estimated payments are reported on Form 1040-ES, which contains a worksheet for figuring the amounts to pay.
Paying State and Local Taxes
If you live in a state and/or municipality that charges income tax, your employer will withhold the appropriate amounts from your paycheck. These local income taxes do not affect your payroll taxes. If you are self-employed, you might have to pay estimated state/local taxes on your income.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.