Payroll Tax vs. Income Tax: Which Should Employers Pay?

Filip Dimkovski - TBR writer
By Filip Dimkovski
Michelle Meyer - Editor for TBR
Edited by Michelle Meyer

Published October 5, 2022.

Two people sitting at a desk having a discussion with an infographic about the various aspects of law between them

As an employer, you are responsible for withholding taxes from your employees' paychecks and remitting those funds to the government. Oftentimes, however, employers are confused regarding the type of taxes as well as the amount they must withhold, which is why the difference between payroll and income tax is misunderstood.

Due to this confusion, employers might pay both types of taxes in excess, which leads to reduced profits and bleeding revenue for the company. But, of course, everyone wants to ensure payroll compliance and avoid paying hefty fees. So, to avoid this, it's important to understand the difference between payroll and income tax, since every company is legally obligated to run payroll.

» How do you ensure payroll compliance? Follow these tips to avoid penalties

What Is Payroll Tax?

Payroll tax is imposed on employers based on the salary and wages paid to their employees. In the United States, for example, there are two payroll taxes: Social Security tax and Medicare tax.

Social Security tax is a federal payroll tax that's used to fund the Social Security program, which provides benefits to retired and disabled workers, as well as their families. The tax rate for Social Security is 6.2% for the employer and 6.2% for the employee, for a total of 12.4%.

Medicare tax is also a federal payroll tax that's used to fund the Medicare program, which provides health insurance to retired and disabled workers, as well as their families. The tax rate for Medicare is 1.45% for the employer and 1.45% for the employee, for a total of 2.9%.

What Is Income Tax?

Unlike payroll tax which is imposed on businesses, income tax is imposed on individuals based on their annual income. In the United States, there are two types of income taxes: federal and state.

Federal income tax is imposed by the federal government on all taxable income. The rates for federal income tax range from 10% to 37%, based on how much you earn every year. Individuals that earn more than $540,000 annually are in the highest tax bracket, so they'll have to pay 37% of the amount over $540,000.

State income tax is imposed by individual states on all taxable income. The tax rates for state income tax vary from state to state, but they are generally lower than the federal income tax rates. Some states like Alaska and Florida have no state income tax at all, while California's rates range from 2% to 13%, depending on your income.

Regarding income tax, it is primarily used to provide funding for national defense as well as foreign affairs.

What Tax Should Employers Pay?

As an employer, you are primarily responsible for paying payroll tax, as you are not responsible for paying taxes on your employees' earnings. Payroll tax is based on salaries, while income tax is based on the revenue streams an individual receives, which are not your responsibility.

Keep in mind that you are also required to withhold income tax from your employees' paychecks and remit those funds to the government. However, this is not considered payroll tax since it's money that's being withheld from the employee, not the employer. Therefore, you are only responsible for paying payroll tax, not income tax.

» Who is responsible for payroll? Discover whether HR or finance must perform this function

Final Thoughts

Now that you've understood the key differences between payroll and income tax, you'll know how to remain tax-compliant while maximizing the revenue for your company. You'll have to remember that you hold full responsibility for the payroll tax of your business, while income tax is the responsibility of your employees.

Of course, you might need to pay income tax on the earnings you personally receive since the owner of the company is also considered to be an employee. With this knowledge, you can be sure that you'll always be payroll compliant, helping you avoid penalties for non-compliance, which can be quite costly.

» Still uncomfortable with tax compliance? Consider outsourcing to a PEO

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