Payroll tax vs. income tax explained (definition & examples)

What is payroll tax?

Payroll tax refers to the taxes deducted from employees' wages and salaries, and contributions made by employers. These taxes fund social insurance programs such as Social Security, Medicare, and unemployment benefits. 

While employees see payroll taxes as a deduction from their paychecks, employers also contribute an equal amount. The tax burden is shared.

Who pays payroll tax?

Both employees and employers share the responsibility of paying payroll taxes. 

• Employees have taxes deducted from their wages, while employers match these contributions for certain taxes.
• Self-employed individuals handle their payroll tax obligations, covering the employee and employer portions.

Note: If you're looking for ways to automate the process of deducting payroll tax, then consider outsourcing your payroll processes for better efficiency.

Components of payroll tax

Payroll taxes include several key components:

• Federal Income Tax Withholding: Employers deduct federal income taxes based on the employee’s earnings and allowances listed on their W-4 form.
• Social Security Taxes: Both employees and employers pay 6.2% on wages up to a $168,600 limit for 2024.
• Medicare Taxes: Both employees and employers contribute 1.45% on all wages. Employees earning over $200,000 pay an additional 0.9%.
• Unemployment Taxes: some text
  • FUTA (Federal Unemployment Tax Act): Employers pay 6% on the first $7,000 of each employee’s wages every year. If the employer pays state unemployment taxes on time, they receive a 5.4% credit, reducing the FUTA rate to 0.6%.
  • SUI/SUTA (State Unemployment Insurance/State Unemployment Tax Act): Rates and wage bases vary by state. New employers usually pay a flat rate for a few years before moving to a rate based on their contributions to the state’s unemployment fund.
• State and Local Income Taxes: Employers may also deduct local and state income taxes based on where the employee works.

Note: all of these tax rate percentages are accurate as of September 26, 2024.

How to calculate payroll tax

To calculate payroll taxes:

1. Determine gross wages: Calculate the total amount paid to the employee before deductions.
2. Calculate taxable wages: Subtract any exempt benefits from gross wages.
3. Apply tax rates: Use the relevant rates for Social Security, Medicare, and other taxes.
4. Account for employer contributions: Add the employer’s share of the taxes to the employee’s contributions.

For instance, if an employee earns $6,150 with $100 in exempt health care insurance, calculate Social Security and additional Medicare taxes on $6,050.

What is income tax?

Income tax is a tax imposed on the income earned by individuals, businesses, and other entities. 

The federal government, most state governments, and some local governments collect this tax to fund various public services and government operations. It applies to various types of income, including wages, salaries, interest, dividends, and business profits.

Who pays income tax?

Individuals and businesses pay income tax based on their earnings:

• Employees have income tax deducted from their paychecks by their employers, who then remit it to the appropriate tax authorities.
• Self-employed individuals must manage their tax payments and file quarterly estimated taxes.
• Small businesses also pay income tax on their profits.

Components of income tax

Income tax consists of several key components:

• Taxable incomes: The income subject to tax, including wages, salaries, and business profits.
• Tax rates: Income tax rates vary and increase with higher income levels, meaning higher earnings get taxed at higher rates. Rates may differ by state.
• Deductions and credits: Deductions and tax credits reduce taxable income or tax liability. Some examples include charitable donations and certain business expenses.

Payroll tax vs income tax comparison

The below comparison will explore the key differences in application, tax rates, employer and employee responsibilities, and calculation methods, providing clarity on the complexities of the U.S. tax system.

Payroll tax example

Please note that the following is simplified for brevity, and many factors impact tax calculations.

Let’s consider an employee named Sarah. Every year, she earns $55,000 and gets paid every two weeks. As a new employer in Florida, where the SUI rate is 2.7% on the first $7,000 of wages per employee, here’s how Sarah’s payroll taxes will get calculated:

For each pay period:

• Gross wages: $2,300
• Social Security tax withheld: $142.60 (6.2% of $2,300)
• Medicare tax withheld: $33.35 (1.45% of $2,300)
• Total FICA taxes withheld: $175.95
• Net wages after FICA taxes: $2,124.05

The employer’s part of payroll taxes for Sarah's pay period includes:

• Social Security tax (employer’s share): $142.60 (6.2% of $2,300)
• Medicare tax (employer’s share): $33.35 (1.45% of $2,300)
• FUTA tax (assuming a 5.4% SUTA credit): $13.80 (0.6% of $2,300)
• Reemployment tax: $62.10 (2.7% of $2,300)
• Total employer tax burden: $251.85

Once Sarah’s cumulative wages exceed $7,000, you won’t need to pay FUTA and SUTA taxes for the rest of the year. You’ll only be responsible for the $175.95 FICA taxes per pay period.

Also, since Sarah’s annual earnings do not exceed the $147,000 Social Security wage base limit or the $200,000 Medicare threshold, her Federal Insurance Contributions Act (FICA) withholdings will remain consistent throughout the year.

Income tax example

Please note that the following is simplified for brevity, and many factors impact tax calculations.

To illustrate how the progressive income tax system works, let’s use an example of Alex, who has a taxable income of $50,000 for the year and is filing as a single individual.

Here’s how Alex’s income tax will be calculated based on the current tax brackets:

1. 10% Bracket: The tax authority taxes the first $11,000  taxable income at 10%.

10% of $11,000 = $1,100

2. 12% Bracket: The tax rate for income between $11,001 and $44,725 is 12%.

$44,725 - $11,000 = $33,725

12% of $33,725 = $4,047

3. 22% Bracket: The income above $44,725 up to $50,000 is taxed at 22%.

$50,000 - $44,725 = $5,275

22% of $5,275 = $1,160.50

Adding these together:

• Tax for the 10% bracket: $1,100
• Tax for the 12% bracket: $4,047
• Tax for the 22% bracket: $1,160.50

Total income tax = $6,307.50

Alex does not pay 22% on the entire $50,000 but 10% on the first $11,000, 12% on the next $33,725, and 22% on the remaining $5,275. This progressive system makes sure that the tax rate applies only to the income that falls into each bracket.

FAQs about payroll tax vs. income tax

What is individual income tax?

Individual income tax is a tax levied on a person's earnings from various sources, including wages, salaries, dividends, and interest. Taxpayers can reduce their liability through deductions, exemptions, and credits on their tax returns.

Do workers pay more in payroll taxes or income taxes?

The amount paid in payroll taxes versus income taxes varies depending on individual factors such as income level and deductions. While individual income taxes are the largest source of federal revenue, payroll taxes constitute the second-largest portion.

Is payroll tax flat or progressive?

Payroll taxes are flat, meaning all employees pay the same percentage of their wages regardless of income level. In contrast, income taxes are progressive, with increasing rates as income rises.

Is payroll tax the same as income tax?

Payroll tax differs from income tax. Both employees and employers pay payroll taxes, which cover Social Security and Medicare, while income taxes are paid only by the employees based on their earnings. Employers withhold both types of taxes but only pay payroll taxes.

What taxes are considered payroll tax?

Payroll taxes include Federal Insurance Contributions Act taxes for Social Security and Medicare and Federal Unemployment Tax Act (FUTA) taxes. These taxes get deducted from employees' pay and, in the case of FUTA, paid by employers.

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Data was collected as of September 24, 2024, and is subject to change or update.

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