Sam Brotman, JD, LLM, MBA June 22, 2022 12 min read

Payroll Tax vs Income Tax: What's the Difference Between Them?

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

America has a complicated tax system, and payroll and income taxes confuse many taxpayers, especially when dealing with revenue agents. While all taxes are not the same, understanding the employment tax difference is significant for employers. But what factors come into play when you evaluate payroll tax vs income tax? Income tax comprises federal, state, and local taxes, while payroll tax includes social security and unemployment taxes.

Taxpayers use these terms interchangeably, but there are apparent differences between payroll and income taxes. We'll discuss the difference between payroll and income taxes, employee and employer taxes, and individual income tax vs payroll tax usage. Lastly, we'll discuss the levies considered as payroll taxes to improve your knowledge.

Is payroll tax the same as income tax?

Income tax responsibility falls on the employee, but employers and employees pay payroll tax. Remember that income taxes are progressive, so you pay more if you earn more. But payroll taxes are regressive and require only a tiny portion of your wages. Income and payroll tax are technically different as payroll levies are relatively simple, but income taxes are complex but flexible.

While income taxes are levies imposed by the government, they depend on various factors and make the bulk of your tax return calculations. The government receives income tax, but payroll taxes go to Social Security, Medicare, and other social insurance programs. Besides, payroll tax uses a flat tax rate, while income tax uses a progressive tax rate.

What is the difference between payroll tax and income tax?

The main difference between income and payroll tax is who pays which and what the taxes fund. Payroll taxes are paid by employees and employers to fund Social Security, Medicare, and social insurance programs. Local income taxes are paid by employees to fund public services like transportation, education, and defense.

Payroll tax vs income tax comparison chart

When differentiating income vs payroll tax, employee and employer responsibility, levies, and tax rates are a few things to compare. We'll create a comparison chart for income vs payroll tax to help you differentiate them properly without dependents.

Comparison Payroll Tax Income Tax
Tax Rate The current federal payroll tax rate is 15.3%. The federal income tax rate starts from 10% to 37%.
Levies The government levies payroll taxes on employees and employers. Income taxes are levies on salaries and wages of an employee.
Employer responsibility Withhold employer's share of payroll taxes, Medicare, and social security. Report employee earnings and remit deductions from employees' wages.
Employee responsibility Pay federal and state social security and Medicare tax. Employees pay local payroll taxes based on their country and city. Paying income tax to the Internal Revenue Service. Make payments based on filing status and net income
How to calculate Multiply employees' Social Security tax rate by the gross pay for the current pay period (6.2%). Employers and employees split payroll taxes 50/50. Calculate payroll tax by multiplying the Medicare tax rate (1.45%) by the employee's gross pay. The higher your income, the more income tax you pay. Calculate income tax based on your household income. Subtract deductions and exemptions to get your taxable income. 

How are payroll taxes different from personal income taxes?

Tax rate, levies, employee, and employer, are factors to consider when comparing payroll taxes vs income taxes. Furthermore, how you calculate personal income and payroll tax differ based on their rates, and understanding the difference is significant. Payroll and personal income tax rates vary in various ways, and we will discuss each more in-depth to improve your knowledge.

Difference between income and payroll tax rate

Taxes under the Federal Insurance Contributions Act (FICA) refer to payroll tax, while income tax depends on employees' salaries or wages. Let's dive into the income and payroll tax rate below:

Income tax rate

Income tax rates differ as many states use flat or progressive income taxes. If you're a high-income earner in a state with a flat income tax salary rate, you pay the same tax as every employee. But if you're in a progressive state, you pay as much as you earn.

A flat rate refers to rates that are even across the board. It means that every employee pays the same taxes regardless of income, wages or salary. Colorado, Illinois, Indiana, Kentucky, Michigan, and North Carolina are a few states with flat income taxes for 2022.

Progressive income taxes are a more significant taxation percentage and depend on taxpayers' income and ability to pay. However, Rhode Island, New York, North Dakota, California, New Jersey, Minnesota, Iowa, and West Virginia are a few states paying progressive income taxes to the Internal Revenue Service. But is salary taxed in all states? Unlike California payroll tax, Texas, Washington, South Dakota, Alaska, and Florida have no income tax system.

Payroll tax rate

The Internal Revenue Service set the current Federal Insurance Contributions Act at 15.3%. Employers and employees pay payroll income tax at a flat rate of 7.65%. Remember that payroll taxes payment methods differ by location but do not affect the rate.

Payroll tax vs income tax levies

The Internal Revenue Service levies wage tax vs income tax for different factors. While income and payroll tax are similar, they have differences, and the IRS levies for various reasons.

What is income tax levied on?

Individual income tax is also referred to as personal income tax. This income tax is levied on an individual's wages, salaries, and other types of income. This tax is usually a tax the state imposes. Because of exemptions, deductions, and credits, most individuals do not pay taxes on all of their income.

The IRS offers a series of income tax deductions and tax credits that taxpayers can use to reduce their taxable income. While a deduction can lower your taxable income and the tax rate used to calculate your tax, a tax credit reduces your income tax by giving you a larger refund of your withholding.

What are payroll taxes levied on?

The federal government levies payroll taxes on wages and self-employment income. A payroll tax is a tax on employees and employers to fund Social Security, Medicare, and other social insurance programs. Employees usually have these taxes withheld from their paychecks, while employers pay them in addition to any other taxes they owe.

However, most economists agree that employees bear the actual cost of employer payroll taxes in the form of lower wages. The revenues go toward funding Social Security, which pays benefits to retirees, persons with disabilities, and survivors of deceased workers.

Employee vs Employer taxes: who pays what?

Payroll tax is mandatory by the Internal Revenue Service for employers and employees of any business organization. But what is the difference between an income tax and a payroll tax to employers and employees? As an employee or employer, do you know who pays what between payroll vs income tax? We'll discuss payroll tax responsibilities for employers and employees to identify the differences.

Employees income tax and payroll tax responsibilities

Social security and Medicare tax, state and federal income tax, and applicable local and payroll tax responsibilities for employees.

1. Social security tax

Social Security tax is the money the Federal Insurance Contributions Act (FICA) authorizes employers to deduct from employees' wages or salaries. It is a payroll tax collected by the Internal Revenue Service to support individuals that require survivorship benefits.

2. Medicare Tax

Medicare tax, popularly known as hospital insurance tax, is a percentage deducted from employees' gross wages. The IRS allows income tax withholding from employees paycheck for federal employment tax with a processing payroll software. The government established the medical insurance program in 1965 to address health care problems for the populace.

3. Federal Income Tax

The federal income tax is the United States' most significant revenue source and is mandatory for employees in the country. It is a tax on annual earnings for individuals, sole proprietorships, limited liability companies, nonprofits, and other business organizations.

4. State Income Tax

If you live and work in the same state, the rules mandate you to pay income tax. State income taxes are taxes levied by individual states on the wage or salary of their residents. Remember that many states' income tax rules are different, and understanding how they work is crucial. While many states adopt the flat or progressive income tax approaches, some states have no tax income at all.

5. Applicable local taxes

Local tax, also known as municipal tax, is a county or state assessment to fund public services. It is a local government imposed tax on small business owners, residents and workers in a specific location. So, the payment becomes mandatory if you work in a county with applicable local laws.

Employers' payroll tax and income tax responsibilities

Social security and Medicare tax, federal and state unemployment taxes, and applicable local taxes are payroll tax responsibilities an employer pays.

1. Social security tax

The Internal Revenue Service Social Security tax rate is 6.2% for employers. These employers share the social security tax bill with workers, enabling them to remit the combined 12.4% to the appropriate authorities. This deductible business expense is a payroll tax responsibility for employers.

2. Medicare tax

While additional Medicare tax has no wage cap, it is a shared responsibility of employers. The Internal Revenue Service imposes this federal types of taxes on employers and allows them to share the burden with workers.

3. Federal Unemployment Taxes (FUTA)

The federal unemployment tax is the 6% of the first $7,000 every employee in an organization makes in a year. Unlike similar payroll taxes, the federal unemployment tax payment is employers' legal responsibility. If a business organization has 10 workers and each earned at least $7,000 in annual wages, the federal unemployment tax payment equals $4,200. However, an employer stops this payment when an employee's annual wages exceed $7,000.

4. State Unemployment Taxes (SUTA)

Many states impose unemployment taxes ranging from 2% to 5% on employers living or working in the state. While this payroll tax rate has periodic updates in many states, the tax amounts become mandatory for employers. However, employees in Pennsylvania, New Jersey, and Alaska share state unemployment taxes payment with employer portion.

5. Applicable local taxes

Employers must comply with applicable payroll taxes in different states. The Internal Revenue Service mandates this payment for employers because the rules differ in various counties or municipalities. While there are local taxes on employers conducting business in an area where employees live and play a significant role.

Individual income tax vs payroll tax usage

Collecting taxes is an ideal way for governments to generate public revenue. The Internal Revenue Service enforces tax collection for the government. But how do governments use the collected individual income and payroll tax? We'll discuss the usage of payroll taxes and individual income tax to aid your understanding.

How are income taxes used?

The government imposes income tax on individuals and businesses and collects taxes for foreign affairs and national defense programs. The United States government uses income tax to fund public services, provide goods for citizens, pay law enforcement and other governmental obligations.

Are you wondering how governments service interest on the national debt? Look no further. It is one of individual income tax usage. These taxes are beneficial for funding social programs such as human and physical development, which in turn serve local communities.

How are payroll taxes used?

Payroll taxes are money deducted from employers' wages and salaries and remitted to the federal government. While the government receives payroll services and taxes from the Internal Revenue Service, the funds serve different purposes. The government funds Medicare, which is health insurance, federal and state Social Security, and other social insurance programs for the welfare of society. Furthermore, these taxes fund unemployment insurance and federal employees.

Our conclusion on the difference between payroll and income tax

Many taxpayers ask, “what is the difference between income tax and payroll tax”? Although income and payroll taxes creates confusion for many taxpayers, there are apparent differences. Tax rates and what the taxes fund are significant differences between payroll and income tax. While income tax is the responsibility of employees, workers and employers are responsible for payroll taxes.

Whether you're self-employed or working for a business organization, income tax is your responsibility. Remember that you can withhold some income and payroll taxes on your tax forms at the state level but pay at the federal level if you qualify. A municipal bond is a perfect example of tax liability that can be exempt on a w-4 form as workers’ compensation.

FAQs on income and payroll taxes

Is payroll tax flat or progressive?

Unlike the individual income taxing system, payroll taxes are flat and not progressive. It means that every business organization employee pays the same tax percentage regardless of income. Progressive tax systems do not have fixed tax rates, and the Internal Revenue Service charge employees and employers based on their income.

The commission charge higher-income individuals high percentages, and lower-income earners pay lower rates. But in a flat system such as payroll taxes, the Internal Revenue Service assigns one tax rate to all taxpayers.

Is payroll tax income tax?

Payroll tax is not income tax; the critical difference is that employees pay both, while employers only pay payroll taxes. The Internal Revenue Service enforces income taxes on citizens. Employers withhold income and payroll taxes on employees' paystubs when they make the payroll. Income and payroll taxes affect employees differently.

What taxes are considered payroll taxes?

Federal unemployment income, Medicare, and social security are payroll taxes. Contractor and termination payments, leave, allowances, and fringe benefits are other items included in a payroll tax. Employees pay these taxes through payroll deductions. Workers and employers share Medicare and social security taxes while self-employed individuals pay each.

Resources:

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Last updated: December 3, 2022

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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