People often confuse themselves between payroll and Income tax. Both are employment taxes but differ in various ways. Income tax is paid by employers whereas payroll tax is paid by employers and employees.
Moreover, both the payroll and income taxes vary a lot depending on the employee classification.
In the coming section, we have differentiated payroll and income tax on four levels: definition, tax rate, payroll withholding, and usage.
| Difference | Income Tax | Payroll Tax |
|---|---|---|
| Contributed By | Solely contributed by an employee | Both parties (employer, and employee) contribute |
| Tax Rate | From 10% to 37% (Depends upon annual income) | FICA Taxes: 15.3% (7.65% for employees) |
| Varies on Employee Classification | Yes | Yes |
| Usage | Public well-being (education, defense) | Retirement benefits or health insurance |
Explaining Payroll Tax
Payroll taxes are deducted from an employee’s salary and wages. They are paid in half by employer and employee.
Payroll tax is also known as FICA tax as it is created by the Federal Insurance Contribution Act. These taxes contribute to insurance programs like social security and Medicare.
Explaining Income Tax
Income tax is applied to the income of an employee. These are not paid by employers and are deducted from the compensation paid to the employee.
These taxes are imposed by the federal, state, and local governments. Moreover, the Internal Revenue Service (IRS) is responsible for collecting Income taxes.
Payroll Tax Rate
Payroll taxes are regressive, they use a flat tax rate on all kinds of income. The FICA tax rate is 15.3% which is divided between employee and employer, so both pay a 7.65% flat payroll tax to the IRS.
Income Tax Rate
Income tax rates are progressive, you have to pay more tax if you earn more. Depending on the earnings of an employee, the amount of taxes a person needs to pay varies accordingly.
Also Read: 2023 Tax Brackets vs 2022 Tax Brackets
These taxes are not paid by the business rather they are withheld by the company and sent to the IRS directly.
How Much Payroll Tax to Withhold?
Payroll taxes are divided into four layers: social security, medicare, FUTA, and SUTA. We have covered each section in detail.
1 – Social Security
Both the employer and employee pay 6.2% for Social Security taxes. 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 (IRS) to improve the lives of individuals.
2 – Medicare
In addition to social security taxes, the FICA also includes Medicare taxes as well. The health care program is funded by 1.45% of the employee’s salary paid by both the employer and the employee.
The total FICA taxes include both the social security and medicare taxes with a rate of 15.3%. Furthermore, each party (employer and employee) gets to pay 7.65% of the FICA taxes.
3 – Federal Unemployment Tax (FUTA)
Unlike Social Security and Medicare taxes, which are deducted from employee earnings, FUTA is an employer-only tax that is mandatory to pay as stated by the law.
For individuals, sole proprietorships, limited liability corporations, nonprofits, and other business entities, FUTA is charged on annual earnings.
4 – State Unemployment Tax (SUTA)
SUTA rates vary from state to state. Some states do not have unemployment taxes at all, whereas many states use flat or progressive income tax schemes.
Employers who reside in or work in a state are subject to unemployment taxes in their respective regulations, which can range from 2% to 5% in several states.
How Much Income Tax to Withhold?
Federal income tax is determined by the information on your employee’s Form W-4, including filing status, dependents, and requests for additional withholding.
Employees must complete Form W-4, and Employee’s Withholding Certificate when they are hired. It is advisable to follow the rules mentioned in IRS publications 15 to determine how much to withhold for federal income tax.
The percentage technique and wage bracket approach are the two ways to calculate federal income tax.
Applicable Local Taxes
Local tax, often referred to as a municipal tax, is a fee that the local government imposes on local citizens, small company owners, and employees.
Therefore, if you operate in a state where there are applicable local taxes, you need to comply with them. Moreover, since each state has different regulations, the tax rate varies depending on the state.
Usage of Payroll Tax
Governments use these taxes to directly or indirectly provide benefits to their citizens.
For example, your social security taxes make into a fund for retirement benefits and disability insurance, while Medicare covers medical expenses for those who are 65 and older and young people with certain disabilities.
Moreover, federal employees and unemployment insurance are also supported by payroll taxes.
Usage of Income Tax
Public services like defense, education, and transportation are paid for via income taxes. The U.S. government uses income tax revenue to fulfill its duties to its citizens, including paying for law enforcement and other government functions.
Conclusion
Payroll taxes and income taxes are deducted from employees’ and employers’ paychecks. The federal government levies the payroll tax. It is divided equally between the employee and the employer to pay for Social Security and Medicare services.
Contrarily, income tax is paid completely by the employee, but the employer is still responsible for deducting the appropriate amount from the employee’s paychecks.
It can be difficult to calculate tax withholdings, especially for small business owners who have multiple employees and find it hard times to deal with the IRS regulations.
The good news is that you can work with a CPA to manage your payroll and get help from a team of tax experts to avoid any tax regularities. Moreover, it is often noticed that business owners pay extra money in taxes since they don’t understand most of the legalities.
With the right consultation, you can save your money and avoid the hassle of getting into complex tax regulations.
