What are Payroll Taxes and How do they work?

Introduction

If you’ve ever looked closely at your paycheck, you’ve probably noticed several types of taxes being withheld—like Social Security, Medicare, and federal income tax. But what exactly are these taxes, and where does that money go?

In this post, we’ll break down the key types of payroll taxes, what they fund, and why they matter.

1. What are Payroll Taxes?

Payroll taxes are taxes employers withhold from employees’ wages and are used to fund specific federal programs. These include:

 Social Security Tax

• Helps provide income to:
• Retired workers
• Disabled individuals
• Survivors and dependents of deceased workers

• The current rate (as of 2025) is 6.2% from the employee, and 6.2% from the employer, up to the annual wage limit.

 Medicare Tax

•  Helps fund medical benefits for:
• People aged 65 and older
• Certain younger individuals with disabilities

• The standard rate is 1.45% from both the employee and employer.

• Employees earning above a threshold (e.g., $200,000 for single filers) also pay an additional 0.9% Medicare tax.

2. What Is Federal Income Tax? 

Unlike payroll taxes, which are earmarked for Social Security and Medicare, federal income taxes are used to fund a wide range of national programs, including:

• Defense and security
• Veterans’ services
• Education and social programs
• Law enforcement
• Interest on the national debt  

The amount withheld depends on your income, filing status, and information provided on Form W-4.  

3. Why Withholding Matters 

Employers are legally required to withhold certain taxes from your paycheck and send them to the IRS on your behalf. This ensures:

• You stay compliant with tax laws
• Your future benefits (like Social Security) are tracked
• You don’t owe a large tax bill at year-end.  

👉 Tip: Use the IRS Tax Withholding Estimator to make sure the right amount is being withheld from your paycheck.

 

Conclusion

Understanding how payroll and income taxes work can help you make smarter financial decisions and avoid surprises during tax season. Whether you’re new to the workforce or just want to double-check your pay stub, knowing where your tax dollars go is always a good move.