Payroll taxes and income taxes are often confused and used interchangeably without a clear understanding of what they really mean—but they’re actually not the same. 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.)
Here’s a breakdown of the differences between payroll tax and income tax for an easier view. Afterwards, we go into the specifics of each type of tax to help you understand it better.
Payroll Taxes | Income Taxes | |
|---|---|---|
Purpose | Funds Social Security and Medicare | Funds government programs, services, education, and operation |
Rate | 6.2% for Social Security, 1.45% for Medicare | Varies by employee’s salary and location |
Who Pays the Tax | Both employers and employees | Employees only |
Who’s Being Paid | Federal government | Federal, state, and local governments |
Employer Responsibilities |
|
|
Nuances | Tax rates may change due to legislation and economic conditions | Some benefits may come out pre-tax, and some states don’t have income tax at all |
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 today 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 2023, both employer and employee pay 7.65% (6.2% and 1.45%, respectively) on the first $160,200 of the employee’s earnings. There is also an additional Medicare tax for those earning $200,000 and above.
If any employee’s income exceeds $160,200 in 2023, 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.
Related:
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 for each 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 you need to withhold state or local income 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 certain areas in states like New York and Arkansas are subject to county or other local taxes.
State-by-State Income 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 or click on the map below to find the rules for the specific state you want to look into.
State Payroll Directory
Employment Tax vs Payroll Tax vs Income Tax
In addition to payroll tax vs income tax, you may have heard the term “employment taxes.” The IRS uses it to refer to payroll, income, and unemployment taxes. Although some websites cluster unemployment taxes with Social Security and Medicare as payroll taxes, 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. As part of handling the payroll process, 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. Learn more about how this provider works in our Gusto review—or check out our guide to the best payroll software to find other providers.
Payroll Tax vs Income Tax Frequently Asked Questions (FAQs)
How do audits work for a small business?
Audits for small businesses involve a review of their financial records by the IRS or state tax agency to ensure compliance with tax laws. Non-compliance can result in penalties, interest, and payment of back taxes. To minimize the risk of payroll tax audits, a small business should:
- Keep detailed and organized financial records
- Review tax filings for accuracy before submission
- Regularly consult with a tax professional for advice
- Implement internal controls to prevent fraud and errors
To ensure compliance, small businesses should:
- Properly classify workers and accurately calculate and withhold taxes
- Timely deposit withheld taxes and employer contributions
- File required payroll tax forms with the appropriate federal and state tax authorities
- Keep accurate records of income and expenses
- Consult with a tax professional
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. On the other hand, 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.
