It’s hard to keep track of when labor is taxable and when it’s not. The rules around when labor is taxable can be confusing, and if you’re not careful you could end up paying more taxes than you need to.
We’ve made it easy for you to understand the tax laws around labor with our free guide. Inside, we’ll walk you through everything from what counts as taxable labor to how to report it on your taxes.
Is Labor taxable? Labor is taxable as well as non-taxable. It depends upon the nature of the work being performed. Each state has different law pertaining to labor tax.
Is Labor Taxable?
Individual income taxes and payroll taxes are the backbones of the tax revenue in the United States. The individual income tax system in the United States is progressive, combining a highly progressive rate with a more regressive payroll tax. While the United States tax code is progressive, most individuals are taxed.
The tax burden on families is frequently lower than that of single, childless workers earning an equivalent pretax income due to provisions in the tax code that benefit families.
The Organisation for Economic Co-operation and Development (OECD) has an annual report on labor tax burdens in the United States and 35 other developed countries. According to OECD data, single childless workers earning an average salary in the United States paid a tax burden of 29.8 percent from income and payroll taxes in 2019, up 0.2 percentage
In the United States, labor continues to bear a lower tax burden than it did prior to the Tax Cuts and Jobs Act (TCJA) lowering individual income tax rates beginning in 2018. Single childless workers had a 31.8 percent tax wedge in 2017, compared with 2 percentage points less in 2019.
The tax wedge in the United States in 2019 was 31.6 percent after taking into account sales taxes, which reduce earnings’ purchasing power.
Because there is a negative correlation between the tax wedge and employment, policymakers in the United States and other OECD nations should look for methods to make labor taxation less onerous in order to enhance labor market efficiency. [When the coronavirus epidemic eases down, this will be critical as policymakers pursue a robust labor market and economic recovery in the United States.]
Calculating Tax On Labor
Individual income taxes are levied by federal, most state, and sometimes local governments to pay for government services. Second, both employees and employers must pay payroll taxes to the federal government.
The employer payroll taxes, in the end, are passed on to employees in the form of increased prices for goods and services. Payroll taxes support federal programs such as Social Security, Medicare, and Unemployment Insurance (UI).
The tax wedge is calculated by subtracting an employee’s net take-home pay from his or her total labor costs to the employer. The OECD adds a worker’s income tax payment, employee payroll tax payment, and employer-side payroll tax payment to arrive at a country’s average wage to compute the tax wedge.
The OECD determines this number by dividing the total amount paid into three taxes by the average employee’s total labor cost, or what the employee would have made had these three taxes not been in place.
The US tax wedge is the total labor cost of the average worker (what the worker would have earned without the taxes) divided by the income tax, employee-side payroll tax, and employer-side payroll tax.
The tax wedge in the United States differs from that of other OECD countries in that it does not include a value-added tax (VAT) on purchases. However, the state sales taxes on goods are imposed in the United States.
The Individual Income Tax
The federal individual income tax is the most significant component of a worker’s tax burden. Federal income taxes are graduated in the United States, with higher rates for higher incomes. The Tax Cuts and Jobs Act of 2017 (TCJA) lowered most individual income tax rates through 2025, with the exception of a married couple filing status. For inflation, the Internal Revenue Service (IRS) raises each bracket’s wage level each year, indexing the individual income tax to inflation.
Payroll Taxes
The United States has three major payroll taxes. The first is a 12.4 percent tax that goes to fund Social Security, known as the old age, survivors, and disability insurance (OASDI) tax.
This tax is charged beginning on the first dollar an individual earns in salary or self-employment income up to a maximum of $137,700 in 2020. The wage cap is adjusted each year to reflect wage growth. The tax is split evenly by employers and workers, although employees pay the entire economic cost of the tax.
The second tax is a 2.9 percent payroll levy to pay for Medicare, commonly known as the Medicare hospital insurance (HI) tax. This levy applies to all wages and self-employment earnings up to the first dollar and is not limited in any way.
The Medicare payroll tax is a percentage of your earnings that you pay to the government, with employers and employees each paying half. An additional 0.9% Medicare payroll tax applies to taxable income above $200,000 (this ceiling is not adjusted for inflation).
There is a third payroll tax that funds Unemployment Insurance, in addition to the employer-side taxes that fund Social Security and Medicare. (UI) is a social insurance program run by the federal government and the state of Texas. This tax is charged to the employer.
The federal unemployment tax is 6% on the first $7,000 of payroll, or taxable wage base. However, state UI taxes may differ from this rate. State UI tax rates and bases can differ significantly in some situations, depending on how often an employee’s employers pay out unemployment compensation (determined by an employer’s experience rating).
An employer will be subject to a higher tax rate if she is expected to hire and fire her employees at a greater frequency. However, the federal and state tax rates are not combined. Employers may credit 90% of their state taxes against the federal tax, resulting in a federal rate as low as 0.6 percent.
How To File Labor On Your Federal Tax?
The IRS requires that employers submit the proper forms to report wages, tips, and other compensation paid to their workers. You must also file Forms 941, 943, 944, 945, and940 electronically or on paper.
State Tax On Labor
Each state has its own way of taxing labor. Following are the examples:
California
The added value created at each stage of a product’s development determines whether or not labor in California is taxable. The main exception is if you’re a reseller.
Illinois
Depending on the circumstances in which the labor is done, it might be subject to sales tax.
- If tangible personal property is not handed over, no labor is taxable.
- When items are sold at a shop, the cost of labor is taxable.
- Installation expenditures are not taxed, even if the labor costs that are paid separately from the tangible personal property’s selling price are charged. Contracted labor expenses that aren’t charged separately are part of the selling price and are taxable.
Texas
All labor and materials expenses in connection with the restoration, replacement, improvement, modification, or upgrade of nonresidential real estate are taxed.
Conclusion
As you can see, the taxation of labor can be quite complex. The best way to determine if a particular type of work is taxable is to consult your state’s department of revenue. Each state has its own laws governing the taxation of labor, so it’s important to know and understand the specific regulations in your state.
