UNLESS YOU’RE self-employed, it’s easy to forget about the Social Security and Medicare payroll tax. Your employer takes the payroll tax from your paycheck before it does almost anything else, including deduct those 401(k) contributions. Those 401(k) contributions may reduce your income for purposes of calculating income taxes, but they don’t shrink the income that’s subject to the payroll tax. Moreover, unless you have self-employment income, you won’t even be reminded that you’re paying the payroll tax when you fill out your federal tax return.
Yet, for many folks, the payroll tax takes a bigger bite out of their income than the federal income tax. Let’s say you and your spouse earn $68,700 a year between you, which was the median household income in 2019. Your only income comes from your job and you claim the standard deduction. In 2021, you would lose $4,834 to federal income taxes and $5,256 to the payroll tax—and this assumes your employer pays half the payroll tax.
Surprised? There may be seven federal income tax brackets ranging from 10% to 37%. But for many families, only the 10% and 12% brackets come into play, plus they can take advantage of deductions and credits. That means their marginal tax rate is fairly low, and their average tax rate is even lower. By contrast, the payroll tax for most folks is a flat 15.3%, with 7.65% paid by employees and 7.65% by employers. That 7.65% is further divided, so that 6.2% goes to Social Security and 1.45% to Medicare.
High-income employees get some relief from the payroll tax once their salary crosses $142,800 in 2021 and $147,000 in 2022. At that juncture, they no longer have to pay any more Social Security tax, though they have to pay the 1.45% Medicare tax on every dollar of income they earn. If their total income—including investment income—is high enough, however, they may get hit with a nasty surprise: the Medicare surtax.
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