Federal Payroll Taxes: Federal Income Tax and FICA Tax

Federal Payroll Taxes: Federal Income Tax and FICA Tax

Net pay is the amount an employer must pay an employee after all deductions are taken. Examples of these deductions include federal income tax, FICA (Federal Insurance Contributions Act), and state or local income taxes. In addition, other deductions may be taken such as health care, pension contributions, and union dues. Federal income tax, and FICA tax, (also known as social security and Medicare tax), are often the largest deductions withheld from an employees’ earnings.

Federal Income Tax

Except for certain types of employment, taxes must be withheld from employees’ earnings for payment of their federal income tax. The amount deducted for federal withholding can vary considerably depending on the employee’s marital status, number of withholding allowances (dependents), and whether any additional withholding is authorized.


Also, the IRS has different wage brackets for different levels of income. Generally, as wages increase, the percentage withheld for federal income tax increases. Circular E from the IRS provides information on the correct amount of federal income taxes to withhold.

Federal income taxes withheld from employees’ wages are not matched by the employer. As each pay period ends, payroll ¬†is calculated and the exact amount that is deducted from each employee for federal income tax withholding is posted to a liability account as a credit. This amount must then be paid to the Internal Revenue Service within a specified period of time.


Employers are required to withhold a portion of each employee’s earnings for FICA tax. The amount withheld funds two federal programs, social security and Medicare. Employers can determine the deduction percentages to withhold and the annual wage limits from the Employers Tax Guide provided by the IRS. Currently the social security rate is 6.2% and the Medicare rate is 1.45%.

Social security has a limit on the amount of annual wages that are taxed, but Medicare does not. For example, an employee who has annual earnings of $125,000, with an annual taxable social security wage limit of $102,000, would owe $6,324($102,000×6.2%) in social security taxes.

Because social security tax has a wage limit, the $23,000 ($125,000-$102,000) earned over the wage limit is exempt from social security tax. It is important to note that this is computed annually, so as a new year begins, social security taxes will again be deducted until the new wage limit is reached.

The amount owed for Medicare tax for the same employee with annual earnings of $125,000 is $1,812.50 ($125,000×1.45%). Since there is no wage limit for Medicare tax, this amount will continue to be deducted on all wages earned.

Employers are also required to contribute to social security and Medicare taxes, and must match any contributions made by their employees. In the above example, the employees total annual contributions for FICA taxes are $8,136.50 ($6,324+$1,812.50). The employer is required to contribute a matching $8,136.50 for FICA taxes.

As payroll  funding is calculated for each pay period, both the employee FICA tax withholding amount and the matching employer amount should be credited to a liability account. The employer portion is an operating expense to the business and is usually posted as a debit to a payroll taxes expense account. FICA taxes are also remitted to the Internal Revenue Service, usually in conjunction with the federal income tax withholding for the pay period.