Understanding the Difference Between Income Tax and Payroll Tax


The IRS receives its funding in two main ways, income tax and payroll tax. It’s important to know the difference between these two forms of taxation because they are collected at different times of the year, apply to slightly different groups of people, and have slightly different effects on those people. This guide will help you understand what each of these taxes are and how they affect your bottom line as an employee.

Understanding the Difference Between Income Tax and Payroll Tax

1) What is income tax?

Income tax is a percentage of a person’s taxable income, or gross income minus any deductions. It’s often referred to as a personal tax because it’s based on individual earnings, although businesses pay taxes as well. In fact, most households pay more in payroll taxes than they do in income taxes. Why? Because employers match employee payroll taxes with their contribution to Social Security and Medicare. Employees then owe these amounts when they file their annual returns.

2) What is payroll tax?

Payroll taxes are paid by employers. Examples of payroll taxes include Social Security, Medicare, unemployment insurance, workers’ compensation premiums, railroad retirement taxes and federal employment taxes. These can be expressed as a percentage of an employee’s wages up to $132,900 in 2015 or $210,800 for married couples filing jointly. The maximum rate for 2015 is 15.3 percent each for employer and employee. The self-employed must pay all their own payroll taxes. Payroll taxes also include contributions to retirement plans such as 401(k) plans or individual retirement accounts (IRAs). Businesses deduct these contributions from gross wages before calculating employees’ taxable income.

3) How are they different?

In general, employment taxes are calculated from your take-home pay, not from your gross wages. This means that Social Security and Medicare withhold a percentage of your net pay instead of a flat dollar amount. Your employer pays a matching amount for both programs, but you don’t pay or receive benefits based on these amounts until you file your annual tax return. Income taxes are different because they’re assessed before any deductions or credits. For example, if you earn $50,000 in salary, subtract standard exemptions to arrive at taxable income of $40,000 before subtracting other deductions such as business expenses or qualified dividends. In most cases when comparing employment taxes to income taxes it’s better to compare apples to apples by looking at pretax rates rather than after-tax rates.

4) Who pays them?

The answer to that question depends on whether you’re an employee or self-employed. When it comes to income taxes, all employees pay them — but how much you owe is determined by your employer. Payroll taxes, on the other hand, are paid directly by employees (not including FICA/Medicare which is deducted from your paycheck). Employers aren’t obligated to pay any of these taxes. In fact, they may actually receive a credit for part of their payroll tax obligation if they meet certain guidelines set out by law.

With the help of payroll software, it becomes easier to have a look at the payroll information and keep a check on these taxes both for employees and employers. Payroll taxes are usually incorporated into your paycheck. As a result, most people don’t realize how much they are really paying in payroll taxes. For example, if you earn $40,000 per year in salary, you will have to give approximately $1048 in payroll taxes each year for a total of 15% of your total earnings being paid to Uncle Sam. What’s worse is that these deductions come directly out of your paycheck before you ever see it so many people don’t even realize they are paying them! Income taxes can be a little easier to manage but both types should always be considered when looking at how much money is coming out of each paycheck and what effect those monies will have on their wallet!


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