Significance

• Payroll taxes include federal income tax, Medicare tax, Social Security tax, state income tax, if applicable, and federal unemployment (FUTA) and state unemployment (SUTA) taxes. According to the Internal Revenue Service, federal income tax is used to provide for national programs, including law enforcement, defense and foreign affairs.
  
  Social Security tax provides retirees and their beneficiaries with retirement benefits. Medicare tax provides medical benefits to workers and retirees who have reached age 65. These two taxes are also called FICA (Federal Insurance Contributions Act) taxes.
  
  According to the U.S. Department of Labor, FUTA taxes are used to fund state unemployment agencies. SUTA taxes are used to provide state unemployment benefits to qualified unemployed workers.
  
  

Employee Taxes

• The employer must withhold specific payroll taxes from employees' income. This includes federal income tax and FICA taxes. The majority of states charge state income tax, but a few others, such as Alaska, Tennessee and Wyoming do not impose it. Furthermore, some cities (for example, New York City) charge city income tax; others (for example, Baltimore) charge local income tax. When applicable, the employer must withhold state, city and local taxes from employee paychecks.
  
  

Employer Taxes

• The employer must pay his portion of payroll taxes. This includes a matching amount of Social Security and Medicare tax--6.2 percent and 1.45 percent, respectively. Most employers are required to pay FUTA tax. Notably, when FUTA taxes apply, SUTA taxes generally apply as well.
  
  

Tax Determination

• Federal income tax amount is based on the IRS withholding tax tables and the employees' filing status and number of allowances (Form W-4). State income taxes depend on the state withholding tax tables and the employee's state income tax form. Medicare tax is withheld at 1.45 percent of all gross earnings. Social Security tax is withheld at 6.2 percent of gross earnings, up to $106,800 for the year.
  
  The FUTA tax rate for 2010 was 6.2 percent of the first $7,000 paid to each employee. The SUTA tax rate varies by state. To determine the SUTA tax amount, the employer multiplies the income paid to each worker (up to the wage base) by the state tax rate. Once the employee has met the FUTA and SUTA wage base, the employer's tax liability for that employee ends. The employer alone is responsible for FUTA and SUTA taxes.
  
  

Considerations

• The employer reports federal income tax and FICA taxes to the IRS quarterly using Form 941 (Quarterly Federal Tax Return). It reports FUTA taxes to the IRS annually using Form 940 (Annual FUTA Tax Return). It reports annual withholding to the Social Security Administration using Form W-2. Furthermore, it performs quarterly state income tax reporting to the applicable state taxation department.