Payroll Tax vs Income Tax: What’s the Difference?

When you’re navigating the complex world of taxes, there is a fundamental element that you, as a business owner, need to have a keen understanding of: the two types of taxes. When we’re comparing payroll tax vs income tax, it’s critical to note that they serve two different purposes, and thus are handled in two different ways. When you know the difference, you’ll be able to better comply with regulations, manage fiscal responsibilities, and avoid potentially looming penalties. 

That’s why, today, we’re diving into payroll tax vs income tax, their differences, and what understanding them can do for your business. 

Let’s get started!

 

What is Payroll Tax?

 

First, we need to understand the definition of payroll tax. Your payroll taxes are what employers are required to pay through the withholding of their employees’ wages in concert with the taxes that the employer has to contribute. Fundamentally speaking, these taxes are used to fund national social programs like Social Security, Medicare, and unemployment benefits. 

Here are a few elements of payroll tax that you need to remember:

 

• Social Security Tax: This refers to the portion of wages that are withheld and paid into the Social Security system that helps retirees, disabled workers, and the survivors of widowed workers. 
• Medicare Tax: This portion is withheld to help fund the Medicare system that delivers health insurance for seniors and disabled individuals. 
• Unemployment Tax: This refers to the tax fund that gives benefits to workers who lose their jobs. 

 

More often than not, your employer is responsible for withholding and remitting these taxes on behalf of employees, but that doesn’t make it any less essential. Employees need to be ensured that they’ll receive the benefits that they are entitled to. 

 

What is Income Tax?

 

Now, when we’re talking about your income tax, it’s a lot different from your payroll tax. Your income tax is the overall tax earnings of an individual or business. For individuals being taxed, it’s levied on salaries, wages, tips, and other income outlets, whether you’re looking at investments, rental income, or retirement distributions. 

The two main types of income tax include:

 

• Federal Income Tax: When it comes to federal income tax, it’s important to know that it’s a progressive system. The more the individual makes, the more the rate increases. Basically, it’s contingent upon the total income and the applicable tax bracket. 
• State Income Tax: Most states impose their own income taxes, and those can vary in terms of the rates and rules. 

 

Unlike payroll tax, its income tax counterpart is based on the total taxable income that is earned by the respective individual or business over the year, not the wages or salaries that are earned during a pay period. That said, if you’re self-employed, you might have to pay both the personal income tax and business income tax, contingent upon the business structure.

 

Payroll Tax vs Income Tax: Key Differences

 

Now that you can decipher between payroll tax vs income tax, we can start to highlight the key differences between the two:

Who pays the tax?

 

• Payroll tax: This is the portion of an employee’s wages that is typically withheld by the employer. The employer also contributes a matching amount so that the employer and employee share the contribution. 
• Income tax: This is the tax that employees or business owners pay based on their overall income, and typically is given directly to the respective tax authority.

 

What does the tax fund?

 

• Payroll Tax: This tax is responsible for Social Security, Medicare, and unemployment benefits. 
• Income Tax: An array of government operations and services are funded through income tax like defense, infrastructure, education, and healthcare. 

 

How is the tax calculated?

 

• Payroll Tax: A flat percentage of an employee’s wages is calculated to make up the payroll tax and is subject to some wage limits for Social Security contributions. 
• Income Tax: Income tax is calculated progressively, which essentially means that as the income goes up, so does the tax rate. It’s important to note that this total is based on annual income after any deductions or exemptions. 

 

When and how is the tax paid?

 

• Payroll Tax: Payroll taxes are collected pretty easily. Essentially, once they’re withheld, the wages are paid on a quarterly or annual basis.
• Income Tax: It’s usually paid once a year, but self-employed individuals or businesses might have to make quarterly estimated tax payments. 

 

Why It Matters for Small Businesses

 

 

If you’re a small business owner, then you know how important it is to understand the difference between payroll tax vs income tax. This knowledge will help you better plan for your financial future and stay in compliance. If you’re not sure where to start, the Estess CPAs team can help you out! We specialize in supporting small businesses like yours in their financial planning and outsourcing their financial tasks.

Are you ready to streamline your accounting efforts? Click here to speak with the team! We’ll work with you closely to fully understand your financial goals and help you meet them! You’ll be able to focus on your operations while we take care of accounting. 

Let us handle the numbers!