Accounting and Finance Foundations

Unit 8

Accounting and Finance Foundations Unit 8: Payroll 658

Payroll

Chapter 19

Lesson 19.3

Student Guide

Employee Taxes

Two other amounts withheld from an employee’s paycheck are the deductions for Social Security and

Medicare taxes. Employees must pay these taxes as a direct result of the Federal Insurance Contribution

Act (FICA), which was passed by Congress in the 1930s during the Great Depression. Until 1991, funds

collected under the Social Security Tax Act were used to fund both Social Security and Medicare benefits.

In 1991, the federal government began collecting funds separately for the two programs.

The Social Security tax rate as well as the income subject to Social Security tax change periodically when

Congress passes new tax-related legislation. In 2013, the Social Security tax was raised to 6.2% of the

first $113,700 in gross earnings. This means that after a person earns $113,700 in gross income in a year,

no Social Security tax will be withheld on any additional money s/he earns during that same year. In other

words, a person who earns $150,000 a year pays the same Social Security tax as a person who earns

$113,700 a year.

The 2013 Medicare tax rate was set at 1.45%. Years ago, there was a maximum income subject to Medi-

care tax; now, however, all wages earned are subject to Medicare tax (unless the employee participates in a

flexible benefits plan that is exempt from Medicare tax). Employers also pay a share of Social Security and

Medicare tax; employers contribute the same amount as their employees contribute. More discussion of

this will come in the following sections.

Example: If Nancy’s gross income is $457 and her year-to-date earnings are still less than $113,700, how

much Social Security and Medicare tax should be withheld?

Social Security tax on $457 = $457 x 6.2% = $457 x 0.062 = $28.34

Medicare tax on $457 = $457 x 1.45% = $457 x 0.0145 = $6.63