In most of the world, payroll tax is a necessary expense that employers must pay when they employ talent. This type of tax is usually designed to maintain infrastructure and social programs, so it’s beneficial to the areas companies and workers reside in.
Each country has its own rules and regulations when it comes to payroll taxes, so having the right resources and expertise to calculate remittances accurately is essential. If you fail to do so, you could face legal actions or fines.
Below, we go over what payroll tax is and cover the crucial information you should know as an employer.
Payroll Tax Definition
When an employee is paid their salary, a percentage of their total pay is withheld by the employer, who then pays it to the government in the form of tax. In many countries, companies pay employer payroll tax too. The money from employee and employer payroll taxes is then used for various purposes by different governments, which may include funding social, health, and employment benefits.
In the U.S., payroll tax expenses are used to fund Social Security and Medicare. In the UK, National Insurance contributions are taken from wages through a system called PAYE (Pay As You Earn) and help fund the National Health Service (NHS). For its part, Canada’s payroll tax is used to fund the employment insurance program.
Self-employed workers such as small business owners, freelance writers, musicians, artists, and contractors are often required to remit payroll tax to the government themselves.
Who Pays Payroll Tax?
In many countries, employers are responsible for deducting payroll tax from the salary of each employee every time they’re paid. They then send these funds, along with their own contributions, to the relevant government agency.
However, people who are self-employed are usually required to send their payroll taxes to the government themselves. There are tax guidelines to help calculate what percentage of a person’s pay needs to be submitted each year. This percentage is called the payroll tax rate.
How Does Payroll Tax Work?
Payroll tax works differently across the world and can even vary by region or city. For example, in the U.S., there are several levels of payroll tax. These include:
- Federal payroll taxes
- State payroll taxes
- City and county payroll taxes
Generally speaking, federal payroll taxes go toward funding Medicare and Social Security, appearing as MedFICA or FICA on pay stubs. Employers also pay federal unemployment taxes for every employee to the government.
Some states, cities, and counties also have payroll taxes (but not all), and some types of payroll tax are only applied up to a certain dollar amount. For example, income that exceeds $147,000 in the U.S. is not subject to Social Security tax. This is the payroll tax threshold for Social Security payroll tax.
Payroll taxes are often itemized on pay stubs, indicating how much money was taken off and for what. Amounts withheld are shown for federal, state, and municipal income taxes, Medicare, and Social Security.
At a municipal level, payroll tax may be withheld to fund local infrastructures such as road maintenance, public parks, and emergency responders.
In the UK, an individual’s tax code indicates to the employer how much payroll tax they are to deduct from a person’s pay.
As payroll and payroll taxes work differently in every country, global employers should seek local expertise to remain compliant. Working with a global employment partner like Omnipresent can help you stay compliant and save time.
Payroll Tax Vs. Income Tax
While both payroll taxes and income taxes are paid to various levels of government, there are distinctions between the two. In many countries, payroll tax is used to fund specific programs directly, while income taxes represent general funds that go into a government’s treasury. These funds are then drawn upon for a variety of uses.
In the U.S., every person who earns money and pays taxes pays a flat payroll tax rate. This is done up to a yearly cap. In contrast, when it comes to income taxes, a person pays a variable rate of tax based on their earnings, which differs from one person to the next.
Payroll Tax Policies
Every country has its own payroll tax policies. As an employer, it’s important to do your research to ensure you’re complying with them when building a global team.
For example, in the U.S., a company needs to register for payroll tax in the state the company was formed in. An Employer Identification Number (EIN) is needed for this. Generally speaking, payroll tax in the U.S. is state-based. Using the services of a local specialist can help you navigate the process.
How Much Is Payroll Tax?
Payroll roll tax rates vary from fiscal year to year and from place to place. Different countries, states, and municipalities will have different payroll tax rates. A few examples include:
- Employer payroll taxes: social security = 23.6%, unemployment = 5.5%, wage guarantee fund = 0.2%, vocational education and training = 0.6%, accidental insurance = 2.05%
- Employee payroll taxes: socal security = 4.7%, unemployment = 1.55%, vocational education and training = 0.1%
- Employer payroll taxes: pension fund = 18% - 21%, health insurance = 6%, labor risk insurance = 2.41%, life insurance = 0.50%
- Employee payroll taxes: pension fund = 11%, social security = 3%, health insurance = 3%
- Employer taxes: social security = 7.5% - 17%, skills development levy = up to 0.25%
- Employee taxes: Central Provident Fund (CPF) = 5% - 20%
Other Payroll Tax FAQs
Here are some frequently asked questions and answers about payroll tax:
How Do Foreign Companies Pay Remote Employees?
Foreign companies typically have to set up a local entity in order to pay remote employees abroad. However, this can be time-consuming and expensive. Alternatively, foreign companies can use an Employer of Record (EOR) to employ and pay talent on their behalf. EOR services, like Omnipresent's, take care of all payroll and payroll taxes in line with local regulations.
How Do I Know I’m Paying Payroll Taxes Correctly?
To ensure you’re deducting all required taxes from your employees’ pay and paying all other necessary taxes as a company, it’s advisable to hire in-house expertise or work with a payroll provider to conduct payroll calculations, payments, and filings on your behalf.
What if I Operate Abroad?
Large companies operating abroad may wish to conduct payroll tax calculations internally, but the business will need to be incorporated, registered, and staffed in order to pay compliantly.