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When it comes to paying taxes to Uncle Sam, most people only think about income taxes. But in 2021, payroll taxes made up 32.5% of all federal revenue. In fact, almost all businesses, even those without employees, are subject to payroll taxes in some form or another.
It’s also common for taxpayers to think payroll taxes and income taxes are one and the same. That’s not the case, however. There are important differences between the two that both employers and employees should be aware of.
In this business owner’s guide, we explain what each tax is, who is responsible for paying each one, and some of the ways each tax is used when funding state, local, and federal programs.
What is income tax?
Income tax — whether for an individual or for a business — generally applies to income from any source unless tax law specifies otherwise. Income tax is imposed by governments to generate revenue and it’s something that must be paid by both businesses and individuals.
There are many ways to offset or reduce the income tax that taxpayers are responsible for, and some income, such as municipal bond income, is exempt in many cases from income tax.
Furthermore, businesses can also deduct many expenses associated with operating their business in order to reduce the amount of income subject to taxes, which is also known as “taxable income.”
Additionally, there’s a wide variety of credits that can offset income tax, for both individuals and business owners. Though it may sound too good to be true, there’s even instances when all of these credits result in the government paying you. All that said: It is always a good idea to speak with your tax advisor or find a professional who can help identify strategies for deductions and ensure you meet your obligations. .
Though they may cause some hand wringing, most people can actually see how paying income tax makes an impact on their everyday lives. That’s because at the federal level, income tax directly impacts budgets for things like national defense, education, public transportation, and even infrastructure for the roads we travel on. The government chooses how it spends the income tax revenue that gets generated, and many states levy their own income taxes as well.
Next, let’s take a closer look at payroll tax and what it’s used for.
What is payroll tax?
Payroll tax applies only to income from employment, including self-employment. These taxes are paid by both employers and employees.
If you’re employed by someone else, payroll taxes are withheld from your paycheck and then paid by your employer to the government in order to fund various federal social benefit programs. This includes Medicare and Social Security programs.
If you’re self-employed, it doesn’t work quite the same way. Self-employed individuals typically pay what’s known as self-employment (SE) tax, as well as income tax. As the IRS explains “SE tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.”
If you are an employer who is responsible for withholding payroll taxes for your employees, or you’re an employee who is looking over your pay stub, you may be wondering why payroll taxes exist in the first place. Simply put, the federal government uses FICA taxes (which is the abbreviation for the federal payroll tax and stands for the Federal Insurance Contributions Act) are designed to cover the costs of the social programs we already mentioned.
Theoretically, FICA tax revenue cannot pay for other things, though in reality the government simply borrows payroll taxes from itself to fund other programs. Eventually, the government will have to come up with other revenue to repay these loans.
FUTA (which stands for Federal Unemployment Tax Act) covers federal payments to state unemployment agencies. States pay most of the cost of unemployment insurance and levy their own payroll taxes to do so. Some states also charge additional payroll taxes.
Next up, let’s take a closer look at calculating income taxes.
Income tax rates and calculation
To calculate federal income tax, the best place to start is with gross income. This includes all income except for specified exemptions that are allowed by law. The next step would be to reduce gross income by all allowable deductions, allowing you to determine what’s known as your “adjusted gross income” from which you can calculate the taxes owed. .
Federal income tax equals taxable income multiplied by a percentage depending on filing status and income. For the 2023 tax year (due in April 2024), the percentages that apply for individuals and their passthrough entities are in the table below:
|Tax rate||Single||Head of household||Married filing jointly||Married filing separately|
|10%||$0 to $11,000||$0 to $15,700||$0 to $22,00||$0 to $11,000|
|12%||$11,001 to $44,725||$15,700 to $59,850||$22,000 to $89,450||$11,001 to $44,725|
|22%||$44,725 to $95,375||$59,850 to $95,350||$89,450 to $190,750||$44,726 to $95,375|
|24%||$95,375 to $182,100||$95,350 to $182,100||$190,750 to $364,200||$95,376 to $182,100|
|32%||$182,100 to $231,250||$182,100 to $231,250||$364,200 to $462,500||$182,101 to $231,250|
|35%||$231,250 to $578,125||$231,250 to $578,100||$462,500 to $693,750||$231,251 to $346,875|
|37%||$578,125 or more||$578,100 or more||$693, 750 or more||$346,876 or more|
For example, a single individual with $50,000 of taxable income would pay 10% on the first $11,000 of income, 12% on income from $11,001 to $44,725 and 22% on income from $44,726 to $50,000.
C corporations always pay income tax of 21 percent on their taxable income.
You can see historical tax brackets here.
Payroll tax rates and calculation
The 2023 FICA tax rate equals 15.3% of employment income, with 12.4% for Social Security and 2.9% for Medicare.
However, the 6.2% employee portion of Social Security tax (see below) does not apply to employment income over $160,200 when tax time for 2023 rolls around. In 2022, it was $147,000. An additional Medicare tax of 0.9% is levied on employment income exceeding a certain threshold — $200,000 for single filers in 2023.
FUTA tax applies to the first $7,000 of employment income and will never exceed 6%. A credit can reduce FUTA to as low as 0.6%, but that depends on which state the business operates in and other factors. State unemployment taxes vary.
Employee vs. employer payroll taxes
Employers and employees generally split FICA taxes down the middle, with each paying 7.65% — which equates to 6.2% for Social Security and 1.45% for Medicare. Does your business have employees? If so, you’ll have to pay the employer portion of payroll tax, plus withhold the employee’s portion and send it to the government. Failure to do so can bring unwanted attention from the
Self-employed individuals have the worst of all worlds — they must pay both the employer and employee portions themselves. This creates an income tax deduction, but self-employed individuals generally pay more taxes.
Only the employer pays FUTA taxes, which don’t apply unless your business has employees.
Differences between income tax and payroll tax
Income tax and payroll tax differ in several ways.
- Applies to all income (unless otherwise specified)
- Gets reduced by many exemptions, deductions, and credits
- Can be used to fund any government program
- Applies only to employment income
- Has few deductions and credits that can be taken advantage of
- In theory, only Social Security and Medicare can be funded.
Both employers and employees must pay income and payroll tax. However, your business has much more responsibility for employee payroll taxes than employee income taxes. You only need to properly withhold employee income tax — your employees remain responsible for accurately calculating it and paying any shortfall. On the other hand, your business is responsible for calculating and withholding employee payroll taxes.
Understanding payroll tax vs income tax is in your best interest
While income taxes often receive more attention, businesses often pay more in payroll taxes, and neglecting them can have unfavorable financial and legal repercussions. Understanding the difference between income and payroll taxes helps you to estimate your future tax burden and stay on top of required filings and payments.
For more information and detail on calculating payroll taxes, please see the step-by-step instructions for calculating payroll taxes. And, if you are looking for a tool to do the heavy lifting, use our guide to compare payroll services side by side.