The Difference between Payroll Tax and Income Tax

When you are the employer of a business, it is your responsibility to withhold tax to your employees. A tax by definition is a compulsory contribution to state revenue, levied by the government on workers’ income and business profits or added to the cost of some goods, services and transactions. It is usually paid in the form of monetary contribution. Taxes are mostly used to fund government projects for the benefit of the public. Employment taxes are computed based on the salaries and wages of employees and are further classified into two: payroll tax and income tax. Most of the time, people use these terms interchangeably, but they have different meanings.

Employment Taxes Missing Deadlines

What is a Payroll Tax?

A payroll tax is a tax that consists of Social Security and Medicare taxes, collectively known as Federal Insurance Contributions Act (FICA). This tax is a shared kind of tax between the employer and employee, meaning both parties contributes their share to it.

A payroll tax is a certain percentage of the employee’s wages. It is computed at 7.65%. As mentioned earlier, this is an employer-employee tax. You withheld 7.65% from your employees’ wages and you also contribute 7.65%.

To further illustrate, assuming you have an employee who earns $800 per pay check. To compute for the payroll tax, you need to withhold $61.20 ($800 x 7.65%) from his salary. In the same way, you will contribute $61.20.

Payroll taxes consist of Social Security and Medicare Taxes. Social security is computed at 6.2%. The good thing about this is Social security has a wage base limit so you only need to withhold up to a certain amount. The wage base limit for 2018 is set at $128,400. Medicare portion is the remaining 1.45%. If social security has a wage base limit, Medicare portion has none. Instead there is a thing called Additional Medicare tax depending on the status of your employee and his income. Additional Medicare tax is 0.9%. You do not need to contribute for this since you do not owe the Additional Medicare tax.

If you are wondering what the purpose of payroll tax is, this tax is used to fund the Social Security and Medicare programs. Some of these include retirement, hospital care, disability, and survivor of deceased worker benefits. This tax commonly provides security for the employee upon his retirement or from any untoward accidents.

What is an Income Tax?

An income tax refers to federal, state and local income taxes. Unlike payroll tax, this tax is not one flat rate. Federal income tax depends on your employees’ withholding allowances. The more the employee claims, the less you withhold for the federal income tax. Federal income tax is supported by the Form W-4 or the Employee’s Withholding Allowance Certificate. To compute for the amount of the federal income tax, you can refer to IRS Publication 15.

State income tax is quite similar to federal income tax. Employees can also claim allowances from state income tax. This is supported by a state income tax withholding form. You might also need to pay for local income taxes depending on the location of your business.

While payroll taxes are used to fund the social and health care benefits of employees, income taxes are used to fund public services like defense, transportation and education. This tax benefits the general public.


After withholding taxes, you are required to file and report them to the Internal Revenue Service (IRS). Your schedule of deposit for both taxes is the same. You will also use the same form to report them (Form 941 or Form 944). It is only important to remember that federal income taxes and payroll income taxes have separate lines in the reporting form.

Both of these taxes are withheld from your employees’ pay checks. As an employer, you should provide your employees pay slips where in the details of all their salaries and wages are shown. The pay slips should also contain the taxes and all other deductions withheld from them. You need to do this to show transparency to your employees that correct amount of salaries and wages are given and proper taxes are withheld.