The employer withholds a percentage from the employee’s payment and later transfers it to the federal government. This is called payroll tax and the percentage is usually 7.65%. It is designed to cover the costs of social security and medical expenses. In contrast, federal income tax directly goes into the general fund of the U.S. Treasury.

Sometimes payroll tax takes care of worker compensation as well. In some cases, local governments also collect payroll taxes, in order to satisfy their first responder, park, road maintenance, and other infrastructural development requirements.

Payroll tax is generated from wages, salaries, and tips of the employees. Employers deduct federal payroll taxes from the earnings of the employees and remit to the Internal Revenue Service (IRS).

Payroll tax is basically a regressive tax. Anyone earning a yearly income of $137,700 is subject to it. So, if you earn more than this amount, you do not need to pay it. For the first $132,000, employees pay 6.2% into Social Security and another 1.45% goes into Medicare on all wages.

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