What Payroll Tax Is and Where It Goes

Payroll tax is money your employer takes from your paycheck and sends to the federal government. It funds Social Security and Medicare — the two largest benefit programs in the United States. Your employer also pays a matching amount on your behalf, though you do not see that deduction on your stub.

The deduction happens automatically every pay period. You do not have to do anything to trigger it. The amount depends on how much you earn and is calculated as a percentage of your gross pay — the total before any deductions.

Payroll tax is separate from income tax, which your employer also withholds. Income tax goes to the Internal Revenue Service and funds general government operations. Payroll tax is dedicated: it goes into two trust funds that pay benefits to retirees, disabled workers, and survivors.

Key Takeaways

  • Your employer withholds 6.2% of your wages for Social Security and 1.45% for Medicare, totaling 7.65% in payroll tax.
  • Your employer pays an equal 7.65% on your behalf, but this does not appear on your paycheck.
  • Payroll tax is capped for Social Security — once you earn above a certain amount per year, no more Social Security tax is taken — but Medicare tax has no cap.
  • The amount you pay now determines how much you receive in Social Security benefits later, based on your earnings record.
  • Self-employed people pay both the employee and employer portions themselves, totaling 15.3%.

The Two Parts of Payroll Tax: Social Security and Medicare

Social Security tax is 6.2% of your wages. It funds retirement benefits, disability benefits, and survivor benefits. The money goes into a trust fund, and your earnings record is tracked by the Social Security Administration. The more you pay in over your working years, the higher your benefit will be when you retire or become unable to work.

Medicare tax is 1.45% of your wages. It funds hospital insurance (Part A) and is the foundation of the Medicare program you become may be able to access for at age 65. Unlike Social Security, Medicare tax has no earnings cap — you pay it on every dollar you earn, no matter how much you make in a year.

Together, these two make up the 7.65% you see labeled as "FICA" or "payroll tax" on your pay stub. FICA stands for Federal Insurance Contributions Act, the law that created these deductions.

The Earnings Cap and Why It Matters

Social Security tax only applies to earnings up to a certain limit each year. That limit changes annually and is set by the Social Security Administration. Once you earn above that amount in a calendar year, your employer stops taking Social Security tax from your paycheck for the rest of that year.

Medicare tax has no cap. You pay 1.45% on all your earnings, regardless of how much you make. Additionally, if your income exceeds a threshold — $200,000 for single filers, $250,000 for married filing jointly — you pay an additional 0.9% Medicare tax on the excess. Your employer withholds this extra amount automatically.

The cap on Social Security tax means high earners pay a smaller percentage of their total income into the system than lower-wage workers do. This is intentional: Social Security is designed to replace a larger share of income for lower earners and a smaller share for higher earners.

How Your Employer Calculates and Sends Your Payroll Tax

Your employer uses your gross pay — your salary or hourly wage before any deductions — to calculate payroll tax. They multiply your gross pay by 6.2% for Social Security and 1.45% for Medicare, then withhold that amount from your paycheck. The calculation happens the same way whether you are paid weekly, biweekly, monthly, or on another schedule.

Your employer then sends the withheld amount to the Internal Revenue Service, usually monthly or quarterly, along with their own matching contribution. They also report your earnings to the Social Security Administration so your record is updated. This is why you receive a W-2 form at the end of the year — it documents how much you earned and how much payroll tax was withheld.

If you work for multiple employers in the same year, each one withholds Social Security tax independently. This can result in you paying more Social Security tax than necessary if your combined earnings exceed the annual cap. You can claim a credit for the overpayment when you file your tax return.

What Self-Employed People Pay

If you are self-employed, you pay both the employee and employer portions of payroll tax yourself. That means you pay 12.4% for Social Security (instead of 6.2%) and 2.9% for Medicare (instead of 1.45%), totaling 15.3% before any additional Medicare tax.

Self-employed people calculate and pay this tax quarterly using Form 1040-ES, or they can pay it all at once when they file their annual tax return. The self-employment tax is reported on Schedule SE, which is part of your tax return. You can deduct half of your self-employment tax as a business expense, which reduces your taxable income.

Self-employed earnings are also subject to the same Social Security cap and Medicare thresholds as wage earners. Once your net self-employment income reaches the cap, you stop paying Social Security tax on additional earnings for that year.

How Payroll Tax Connects to Your Future Benefits

Every dollar of payroll tax you pay is credited to your Social Security earnings record. The Social Security Administration tracks your earnings year by year and uses your highest 35 years of earnings to calculate your retirement benefit. If you have fewer than 35 years of earnings, zeros are included in the calculation, which lowers your benefit.

You need 40 work credits to become may be able to access for Social Security retirement benefits. You earn one credit for each $1,640 of earnings in 2023 (the amount changes yearly), and you can earn up to four credits per year. This means you can earn your 40 credits in as few as 10 years of work.

Your payroll tax record also determines your may be able to access for disability benefits and survivor benefits. If you become unable to work before retirement age, you can file for Social Security Disability Insurance based on your earnings record. If you die, your family members may receive survivor benefits based on the same record.

Frequently Asked Questions

Can I opt out of paying payroll tax?

No. Payroll tax is mandatory for all wage earners and self-employed people. The only exception is certain members of religious groups who have been granted exemptions by the IRS, and even then the exemption is rare and requires specific approval.

What happens if my employer does not withhold payroll tax?

You are still responsible for paying it. If your employer fails to withhold and send payroll tax to the IRS, you can report them to the Department of Labor or the IRS. You should also contact the Social Security Administration to ensure your earnings are credited to your record, since the tax withheld is what creates that credit.

Does payroll tax count toward my income tax?

No. Payroll tax and income tax are separate. Your employer withholds both from your paycheck, but they go to different places and fund different programs. Payroll tax does not reduce the amount of income tax you owe.

Why do I pay payroll tax if I might not live to collect Social Security?

Payroll tax funds more than just retirement benefits. It also funds disability benefits for workers who become unable to work at any age, and survivor benefits for your family members if you die. Additionally, your family members can receive benefits on your earnings record even if you do not live to retirement age.

What if I earned income but did not pay payroll tax?

Some jobs are exempt from payroll tax — certain government employees, some religious workers, and a few other categories. If you worked in an exempt job, you can still file for Social Security benefits based on other work where you did pay payroll tax, as long as you have enough credits from those jobs.