Payroll Tax vs Income Tax: Definitions & Differences
Charlette has over 10 years of experience in accounting and finance and 2 years of partnering with HR leaders on freelance projects. She uses this extensive experience to answer your questions about payroll.
Heather is a staff writer and payroll specialist with several years of experience working directly with small business owners. Her expertise allows her to deliver the best answers to your questions about payroll.
This article is part of a larger series on How to Do Payroll.
Payroll taxes and income taxes are often confused and used interchangeably without a clear understanding of what they really mean. Payroll taxes are paid by both employers and employees, and these funds are allocated for Social Security and Medicare. Income taxes are paid only by employees and include taxes due to the federal, state, and local governments. (Unemployment taxes, paid only by employers, are a separate tax.)
Payroll Taxes | Income Taxes | |
|---|---|---|
Taxes Included | Social Security and Medicare | Federal, State, and Local |
Tax Rates | 6.2% and 1.45%, respectively | Varies by employee: 0% to 37% |
Who’s Being Paid | Federal government (IRS) | Potentially federal (IRS), state, and local tax agencies |
Funds | Healthcare and income supplement during retirement | Public services like transportation, community development, and defense |
Gusto makes processing both payroll taxes and income taxes simple and easy. Fixed rates are set up within the system, so the funds are automatically withheld from employee paychecks during each pay run. It also withdraws the matching Social Security and Medicare tax amounts from the business’ bank account to cover the employer’s portion of these taxes. Try it for free for 30 days.
What Are Payroll Taxes?
When you begin to process payroll, you’re responsible for collecting all payroll taxes (FICA taxes) due. These funds are allocated for Social Security and Medicare. In 2022, both employer and employee pay 7.65% (6.2% and 1.45%, respectively) on the first $147,000 of their earnings. There is also an additional Medicare tax for those earning $200,000 and above.
If any employee’s income exceeds $147,000 in 2022, neither of you will owe Social Security taxes on earnings above that amount. If their income exceeds the applicable threshold amount in the table below, you’ll have to withhold an extra 0.9% Medicare tax on their total taxable earnings that exceed the maximum.
Additional Medicare Tax
Filing Status | Threshold Amount |
|---|---|
Married Filing Jointly | $250,000 |
Married Filing Separate | $125,000 |
Single | $200,000 |
Head of Household | $200,000 |
Qualifying Widow | $200,000 |
Although unemployment tax isn’t officially recognized as a payroll tax per the IRS, you’re still responsible for paying it. It’s a tax that’s paid by employers, and rates differ depending on previous claims filed against your business and how long you’ve been operating. For more details, check out our guide to FUTA Taxes.
What Are Income Taxes?
Income taxes are paid by employees; operate at a federal, state or local level; and fund government spending and public services. Federal income taxes—calculated using an employee’s W-4 form—aren’t fixed rates like payroll tax rates (although some state and local taxes are, depending on where your workers live/work) and vary by employee. The lower an employee’s income, and the more dependents they have, the fewer federal income taxes they will owe. Marital status also plays a role. You can reference IRS Publication-15T to determine federal withholding amounts.
Whether or not you need to withhold state or local taxes depends entirely on where the employee resides (and sometimes where your business is located). States like Florida and Texas don’t have an income tax. And some areas in states like New York and Arkansas are subject to county or other local taxes.
Our state payroll guides detail income taxes per state. They include all state and local tax rates, the appropriate tax agencies for each, and much more. Check out our state payroll directory for all the income tax information you’ll need.
Employment Tax vs Payroll Tax vs Income Tax
In addition to payroll and income taxes, you may have heard the term “employment taxes.” The IRS uses it to refer to payroll, income, and unemployment taxes.
It can be confusing, because some websites mesh unemployment taxes with Social Security and Medicare as payroll taxes. However, the IRS’s tax tutorial clearly states that payroll taxes only include FICA.
As the employer, you’re responsible for withholding payroll and income taxes from employee paychecks if you want to do payroll the legal way. You’re also expected to remit the money to the IRS and other applicable agencies. The good news is that a reputable payroll software, like Gusto, will withhold, manage, and pay all of these taxes for you at no extra cost.
Bottom Line
When you’re not a tax expert, it’s easy to confuse payroll and income taxes. Just remember that payroll taxes consist of the flat rate FICA taxes that both employees and businesses pay to the federal government. You withhold income taxes from employee paychecks—not from your business bank account—to be paid to federal, state, and possibly even local tax agencies.
Gusto makes processing both payroll taxes and income taxes simple and easy. Its intuitive tax system ensures that the appropriate funds are automatically withheld from employee paychecks during each pay run so that there’s nothing extra that you have to worry about. It also withdraws the matching Social Security and Medicare tax amounts from the business’ bank account to cover the employer’s portion of these taxes. Try it today for 30 days free.
