Payroll taxes are levied on wages, salaries, tips, and certain bonuses that you earn from employment

Payroll taxes — Social Security and Medicare taxes — are calculated on your gross income before deductions. This means the tax is taken from the full amount your employer pays you, not from what you take home after health insurance or retirement contributions. The base amount subject to payroll tax is called taxable wages.

The specific items that count toward payroll tax vary slightly between Social Security and Medicare. Social Security tax (6.2% from your paycheck, matched by your employer) applies to wages up to an annual cap — $168,600 for 2024, though this cap increases each year. Medicare tax (1.45% from your paycheck, matched by your employer) has no income cap and applies to all wages. An additional 0.9% Medicare tax kicks in for high earners above $200,000 (single) or $250,000 (married filing jointly).

Key Takeaways

  • Wages, salaries, bonuses, and tips all count as income subject to payroll tax, whether paid weekly, monthly, or as a lump sum.
  • Social Security tax stops applying once you hit the annual wage cap ($168,600 in 2024), but Medicare tax continues on all earnings above that.
  • Certain payments like employer health insurance contributions, retirement plan contributions, and dependent care benefits do not count as taxable wages for payroll tax purposes.
  • Self-employed people pay both the employee and employer portions of payroll tax (15.3% total for Social Security and Medicare combined) on net business income.
  • Payroll tax is calculated on gross income before most deductions, which is why your paycheck is smaller than your stated salary.

What counts as wages for payroll tax

Payroll tax applies to any money your employer pays you for work. This includes your regular hourly wage or salary, overtime pay, bonuses tied to performance or production, commissions, and tips you report to your employer. Severance pay also counts. The timing does not matter — whether you are paid weekly, biweekly, monthly, or as a single lump sum, the full amount is subject to payroll tax in the year you receive it.

Bonuses are treated the same as regular wages. If your employer gives you a holiday bonus, year-end bonus, or signing bonus, payroll tax is withheld from that payment just as it is from your regular paycheck. Some employers withhold at a flat rate (often 22% or 37% depending on the bonus size), while others calculate it based on your normal withholding rate.

What does not count as taxable wages

Several types of employer payments are excluded from payroll tax, even though they are part of your total compensation. The most common exclusion is employer-paid health insurance premiums — what your employer contributes toward your medical, dental, or vision coverage does not count as taxable wages. Employer contributions to a 401(k), 403(b), or similar retirement plan are also excluded, which is why contributing to these plans reduces your taxable wages.

Dependent care benefits (up to $5,000 per year), transit passes or parking benefits (up to certain monthly limits), and life insurance premiums (up to $50,000 of coverage) are also excluded. Reimbursements for business expenses — mileage, meals while traveling for work, equipment — do not count as taxable wages if they are documented properly. Employer-provided education assistance up to $5,250 per year is excluded as well.

Certain one-time payments may also be excluded. Gifts from your employer (not tied to performance) under $25 per year, awards for safety or length of service under $1,600, and moving expense reimbursements can fall outside payroll tax, though the rules are narrow and depend on how the payment is structured.

The difference between Social Security and Medicare wage caps

Social Security and Medicare tax are calculated differently, which matters if you earn a high income. Social Security tax applies only to wages up to an annual limit. For 2024, that limit is $168,600 — once you reach that amount in a calendar year, no more Social Security tax is withheld from your paychecks for the rest of that year. This cap changes annually based on wage growth.

Medicare tax has no cap. Every dollar you earn is subject to the 1.45% Medicare tax, no matter how much you make. If you earn over $200,000 (or $250,000 if married filing jointly), an additional 0.9% Medicare tax applies to income above that threshold. This additional tax is sometimes called the Net Investment Income Tax when it applies to investment income, but the same rate applies to wages.

The practical effect: if you earn $200,000 in a year, you stop paying Social Security tax partway through the year, but you pay Medicare tax on every dollar. High earners pay a larger share of their income toward Medicare than lower earners do.

How self-employment income is treated

If you are self-employed, payroll tax is called self-employment tax, and you pay both the employee and employer portions. The combined rate is 15.3% (12.4% for Social Security, 2.9% for Medicare). You calculate self-employment tax on your net business income — your revenue minus business expenses — not on your gross revenue.

Self-employed people file Schedule SE with their tax return to calculate self-employment tax. You can deduct half of your self-employment tax as a business expense on your income tax return, which provides some offset. If you have both W-2 wages from an employer and self-employment income, Social Security tax still applies only up to the annual cap across both income sources combined.

How payroll tax interacts with deductions and withholding

Payroll tax is withheld from your gross pay before most other deductions. This means if your salary is $50,000 per year, payroll tax is calculated on the full $50,000, even if you contribute to a 401(k), have health insurance premiums deducted, or claim tax withholding allowances. The order of deductions matters: retirement contributions and health insurance premiums reduce your taxable wages for payroll tax purposes, but income tax withholding does not.

Your employer uses the W-4 form you complete to determine how much federal income tax to withhold from each paycheck. This withholding is separate from payroll tax and does not affect how much Social Security or Medicare tax you owe. If you claim more allowances on your W-4, less income tax is withheld, but your payroll tax stays the same.

Frequently Asked Questions

Do tips count as income for payroll tax?

Yes. Tips you receive are subject to payroll tax. You are required to report tips to your employer, and they withhold payroll tax from your regular paycheck to cover the tax on those tips. If tips push your total income over the Social Security wage cap, the cap still applies.

What if I have multiple jobs — do I pay payroll tax on both?

Yes, you pay payroll tax on wages from each job. However, if your combined wages exceed the Social Security wage cap, you may have overpaid Social Security tax. You can claim a credit for the overpayment when you file your tax return, but you will not receive a refund — the credit only reduces your income tax owed.

Are stock options or restricted stock units subject to payroll tax?

Stock compensation is treated differently depending on the type. Restricted stock units (RSUs) are subject to payroll tax when they vest and you gain ownership. Stock options may or may not be taxable depending on whether they are incentive stock options or non-may have access to options. Consult your employer's benefits documentation or a tax professional for specifics.

Does payroll tax apply to vacation payout or paid time off?

Yes. When you receive payment for unused vacation days, sick leave, or other paid time off — whether at termination or as a regular payout — that money is treated as wages and subject to payroll tax.