Payroll taxes are taxes that are deducted from a person’s salary or wages. There are essentially two types of payroll taxes, although this can vary between countries. Generally, there are taxes on wages paid by the employee and those paid by the employer.
A W-2 wage and tax statement indicates how much an employee was paid and how much was withheld on payroll.
In the United States, most employers are required by law to collect payroll taxes to cover employee income taxes. These taxes include deductions for state and federal taxes. Employers must also tax their employees for Medicare and Social Security, two separate federal health, disability and retirement programs.
While the payroll tax is based on the employee’s income, the tax payment comes from both the employer and the employee. The employer, for example, is required to pay half of the Medicare and Social Security taxes on the employee’s earnings. This payment is called withholding tax, because the employer basically withholds this amount of tax from employees’ paychecks. The employee pays the other half in addition to other state and federal taxes.
Payroll taxes are withheld from the employee’s paycheck each pay period.
Under certain circumstances, some paychecks may not be reduced by payroll taxes. In the United States, for example, independent contractors are required to meet tax obligations on their own because, essentially, independent contractors are self-employed. That is, the self-employed person is both the employer and the employee. Some contractors file quarterly tax returns to avoid a large tax payment at the end of the year. Others, typically those who don’t earn large annual amounts, meet their tax obligations once a year.
People can file their taxes online through programs like TurboTax.
Other countries have a prepaid payroll tax system. This means that every time an employee is paid, his salary will be reduced by the amount of the respective tax. Companies may also be required to comply with some of these taxes, depending on the country’s tax rules.
Sometimes the term payroll tax is specific to employer contributions only. In Australia, payroll tax refers to the tax requirements imposed on employers. This is not the amount deducted from the employee’s salary, although Australia does require some employee contributions for things other than payroll tax.
It is important for employers to understand applicable tax laws when addressing their payroll tax obligations. If you don’t withhold the proper amount or meet your own tax obligations, a business can quickly run into trouble with government tax collection agencies. For this reason, some employers choose to use a payroll company or develop a dedicated payroll department.