What the payroll tax funds

You might sometimes find them under different names, but, generally, these are the three main federal payroll taxes: Social Security tax, Medicare tax and Federal Unemployment tax. Social Security is also called Old Age, Survivors, and Disability Insurance or OASDI tax while the Federal Unemployment tax is also referred to as FUTA tax (Federal Unemployment Tax Act). All of them combined make the FICA taxes, which stands for the Federal Insurance Contributions Act.

The amounts employers and employees paid on federal payroll taxes differ. For instance, the 12.4 percent Social Security tax is split fifty-fifty between employer and employee. The Medicare tax is 2.9 percent, and it is also equally split between employer and employee, but higher earners have to pay an extra 0.9 percent. The Federal Unemployment tax is 6 percent, payable by the employer only.

RELATED: 7 Biggest Social Security and Medicare Changes in 2021

Why does the payroll tax have a cap?

That’s a very good question many people would like to know the answer to. What happens to the earnings above the cap of $137,700? According to the Social Security Administration, the initial Social Security program and related taxes proposed by President Franklin D. Roosevelt did not include most high-income workers. In fact, workers making more than $250 per month were not subject to the tax.

However, after being reviewed by the House Ways and Means Committee, the tax exemption was modified and the maximum taxable was set at $3,000 in earnings. This limit was constantly modified until 1975 when the taxable maximum was correlated with the annual average wage increase.