These are two main taxes that every employee has to pay. Though they sound similar they are anything but the same. One affects the rich while the other affects the poor. The proceeds collected are also used differently. In this article, we will explain each tax and see why payroll tax vs income tax is different on so many fronts.
What is Payroll Tax?
This is a flat amount that is deducted from the gross pay. Here, the employer deducts 7.65% from the employee’s gross pay and pays an additional 7.65% from the employer’s pocket.
Payroll tax is divided into two- Social Security and Medicare. Social Security is 6.2% while the remaining 1.45% is Medicare tax. However, if the employee earns more than the Medicare tax threshold, an additional 0.9% of their wages is deducted.
This comes to about 2.35%.
Payroll taxes are fixed taxes that help fund your social security and medicare programs. This includes your retirement, hospice care, health care, and other related benefits.
Related Read: Why affordable online payroll services are win-win for all?
What is Income Tax?
Income tax is a collection of taxes levied at the state, federal and local levels. This is not a flat tax and may vary on a variety of conditions.
The federal tax depends on your W-4 information. This is collected as soon as you join as an employee of an organization. Your income tax returns also depend on the frequency of your wages and the total amount.
The tax rate starts from 10% for income up to $9,875 for singles and $19,750 for married couples filing taxes jointly and ends at 37% for those earning $518,400 and above.
The federal income taxes due are based on ‘tax brackets’; the number for which has fluctuated from time to time. Currently, there are 7 tax brackets available.
However, the rate of state income taxes varies widely from state to state. Some states have a flat state income tax rate, with the likes of Illinois, Michigan, North Carolina, Pennsylvania, Massachusetts, Utah, and Colorado. Others have progressive tax systems where the higher the amount you earn, the more is the tax you owe the state government.
Payroll Tax vs Income Tax
The main difference here is- payroll taxes are paid by both the employer and employee. On the other hand, income taxes are paid exclusively by the employee. However, both these taxes are withheld and paid for by the employers while making the payroll.
These taxes affect employees differently, based on their income levels. For most middle-class and poor households, payroll taxes hit harder.
On the other hand, progressive income taxes hit harder for those with higher incomes. This is because the more you earn, the more you have to shell out in income tax.
As we have explained, calculating payroll taxes is simple. Income taxes have many deductions and tax ceilings to look into, hence are more complex. Usually, many professionals hire experts to do their taxes.
Related Read: 5 Common Payroll Mistakes
How Payroll Tax is Calculated
The payroll tax has changed quite a bit. In 2021, both employers and employees have to pay 6.2% payroll tax (also called FICA tax) as required by the Federal Insurance Contributions
Act. This has a limit of up to $142,800. Each employee can make a maximum contribution of $8,853 each. These limits are modified year on-year as per inflation.
Besides this, both employers and employees contribute 1.45% to Medicare without any limit. The best part of payroll taxes is that it benefits the employees in the long run, especially after retirement.
How Income Tax is Calculated
These are taxes that are only paid by employees. Income taxes are imposed at all levels-county, state, and federal. These help to finance the government. Only nine US states do not levy income tax- Nevada, Alaska, Wyoming, Florida, New Hampshire, Tennessee, Texas, and Washington. The tax rates vary according to the cities and counties you reside in. Many counties and cities impose ‘local’ income taxes.
Your employer will calculate your federal income tax based on your w-4 form. To help you calculate your taxes, employers refer to the IRS’s Publication 5 Circular E. Local and state income taxes can also be withheld and paid for by the employer. For this, you will need to submit a form to your employer for the same.
Over and above this, you are liable to pay income taxes from sources of income like bank interest, dividends, profit from the sale of property or shares, besides your primary employment.
In a nutshell
Based on where you live, you have to pay a flat payroll tax and a host of federal, state, and local income taxes. Though income taxes are progressive, they can be fairly complex and may require the services of professionals if you have multiple sources of income. Payroll taxes are for the employee’s ultimate benefit and are deducted from the gross pay.
Ultimately, the onus to pay payroll taxes is on your employer and the income taxes rest on both you and your employer.
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