Difference between Payroll Tax and Income Tax


Emptech's founder, Jeff Aleixo


Jeffrey Aleixo

payroll tax income tax differences tax compliance

Employers are responsible for withholding taxes from employee wages. Whenever they pay employees, there are certain taxes that employers have to withhold from employees’ paychecks. Employment tax taken out of each employee’s gross wages can be broken down into payroll tax and income tax. Even though the terms payroll tax and income tax are used interchangeably, they are different.

The federal government levies payroll tax on wages and uses most of the revenue to fund Social Security and Medicare. These taxes are withheld at a flat rate from employee pay, with a portion also paid by the employer. On the other side, income tax is a more complex system. It refers to taxing money earned from sources other than work and employing deductions, exemptions and credits. It is used for national defense, social programs and other federal government expenses. 

The Payroll Tax System

In the United States, payroll tax refers to taxes paid under the Federal Insurance Contributions Act, or FICA. This includes taxes paid to support Social Security and Medicare. Social Security tax funds benefits for retirement, dependents of retired workers, and the disabled and their dependents. Medicare tax funds medical benefits for people once they reach age 65.

Payroll tax takes a flat percentage of employee wages, with a portion paid by the employee and the portion paid by the employer. Social Security tax only applies to income up to a certain threshold that is regularly adjusted for inflation, while Medicare tax applies to all wages and salaries.

For 2019, the Social Security tax rate is 6.2% on the first $132,900 of wages paid, up $4,500 from 2018. The Medicare tax rate is 1.45% on the first $200,000 of wages, plus an additional 0.9% for wages above $200,000.

Some states and cities also impose payroll tax, usually paid by employers and self-employed people, but not employees.

Use this detailed guide to help you effectively handle tax responsibilities and stay in compliance with federal, state, and local requirements.

The Income Tax System

Income taxes refer to taxes paid based on how much money employees make from a variety of sources. Income taxes are generally paid on money that is earned at a job or from self-employment, as well as funds from other sources like bank interest, dividends paid by stocks or gains from the sale of assets.

Income taxes are typically used for funding defense and national security programs. Employers are responsible for withholding taxes based on the taxpayer’s W-4 withholding form. When the taxpayer files their income tax return, they either pay any remaining balance or receive a tax refund.

The federal government imposes income tax, as well as many states. Some cities also have their own income tax for people who live or work there.

Overall, the federal income tax system is a progressive tax system, where tax rates are higher for people with higher incomes. Each taxpayer falls into a federal tax bracket. In 2019, there are seven tax brackets based on earnings and filing status—10%, 12%, 22%, 24%, 32%, 35%, and 37%. State income taxes vary considerably from state to state, but most states that have an income tax have a progressive income tax.

Payroll Tax vs. Income Tax

The term payroll tax is frequently used to refer to all employment taxes. While both payroll tax and income tax get taken out of paychecks, they are different types of tax.

Here are some of the key differences between payroll tax and income tax:

  • Payroll tax is typically taxed at a simple flat rate, while income tax is subject to a variety of income-based tax brackets, deductions and credits based on various factors such as whether taxpayers have children or pay interest on a mortgage;
  • Payroll tax is usually set up for a specific purpose, like funding Social Security or Medicare, while income taxes often go into the general funds of federal, state and city governments;
  • When it comes to payroll tax, both the employer and employee share the tax amount equally between them. On the other side, the whole income tax amount is paid by an employee;
  • Income tax is a progressive tax because as the salary of the employee increases, the income tax is also increased. Payroll tax is a regressive tax as high-income taxpayers pay as much as the low-income taxpayers;
  • Even though income taxes help the taxpayers indirectly in some way, the payroll tax is the one that helps the taxpayers directly given that it is used for Medicare and retirement funds.

Staying Ahead of Tax Rules

Employers are responsible for withholding, reporting, and paying employment taxes. Given the complexity of filing tax forms and making payroll tax deposits, it is no wonder that they can often feel puzzled. This is why it is necessary to understand differences between payroll tax and income tax, who is responsible for paying each, and the filing and payment deadlines.

In addition to this, employers can achieve maximum tax compliance, decrease internal resources and recover tax overpayments by outsourcing tax management. This allows them to use a range of automated features, reduce the burden of compliance, avoid making mistakes, and ensure the security of all data. Ultimately, understanding differences between payroll tax and income tax together with tax management solution benefits the organization in terms of time and cost savings, as well as efficiency gains.

Eliminate the cost and time associated with routine tasks and automate calculations, withholdings, deposits, and reporting.
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