As a business owner, understanding the difference between payroll taxes and income taxes is important for payroll compliance and avoiding costly penalties. While both are deducted from employee paychecks, they serve different purposes and follow different rules.
Let’s break down what makes each unique and how they impact your business.
What is Payroll Tax?
Payroll taxes, also known as FICA taxes, are federal taxes shared between employers and employees to fund specific government programs. These taxes include:
- Social Security Tax: This funds the retirement, disability, and survivor benefits of Social Security. For 2025, the employer and employee pay 6.2% of the employee’s wages, for a total of 12.4%. This tax is applied to wages up to a certain limit (the taxable wage base), which is adjusted annually for inflation.
- Medicare Tax: This funds the federal health insurance program for people 65 and older and certain younger people with disabilities. The employer and the employee each pay 1.45% of all wages, for a total of 2.9%. There is no wage limit for the standard Medicare tax.
- For employees who earn more than $200,000, an additional 0.9% Medicare tax is applied, but this is only paid by the employee, not matched by the employer.
- FUTA (Federal Unemployment Tax Act): Futa taxes are paid by employers to fund unemployment benefits. It is generally a 6% tax on the first $7,000 of wages paid to each employee.
- Employers can reduce their FUTA liability by paying their state unemployment taxes on time. However, businesses in FUTA Credit Reduction States (those owing the federal government for a loan to fund their unemployment benefits) will have less of a credit based on a reduced percentage to their credit
What is Income Tax?
Income taxes are imposed at the state and local levels to fund federal government operations. Employers withhold these from an employee’s paycheck based on the information provided on their W-4 form. The amount withheld depends on several factors, including:
- Employee’s total earnings
- Their filing status (single, married, head of household, etc.).
- Any allowances or extra withholdings they have requested.
Unlike payroll taxes, federal income taxes are progressive. This means that higher income levels are taxed at higher rates.
What Are the Differences Between Payroll Tax and Income Tax?
Payroll and income taxes differ in several ways, including who pays them and what they fund.
| Feature | Payroll Taxes (FICA) | Income Taxes |
|---|---|---|
| Who Pays | Employer and employee | Employee only |
| Purpose | Fund Social Security and Medicare | Fund general government services |
| Tax Structure | Flat rate up to wage cap | Progressive rate based on income |
Payroll vs Income Tax Responsibility
Both you and your employees contribute equally to payroll taxes. For every dollar your employee pays toward Social Security and Medicare, you match that contribution. For income taxes, employees bear the full responsibility for payment. Your role is to withhold the correct amount based on their W-4 and remit it to the appropriate tax authorities.
Funding Purposes of Payroll and Income Taxes
Payroll taxes have a specific mission — they directly fund Social Security and Medicare programs that employees can access later in life. Income taxes support the broader functions of government at federal, state, and local levels, with those tax dollars spent on public infrastructure, education, and public services, to name a few.
Payroll and Income Tax Structures
Payroll taxes are specific taxes that both employers and employees pay based on wages. In the U.S., these mainly fund Social Security and Medicare, and both the employer and employee pay a set percentage of the employee’s pay. The rates are fixed, and they only apply up to certain income limits (especially for Social Security). Payroll taxes kick in right when you get paid — your employer withholds your share and sends it to the government, and they also pay their matching share.
Income tax, on the other hand, is a tax on your total income from all sources — not just your paycheck, but also investment income, business profits, etc. It’s paid by individuals (and some businesses), and the amount you owe depends on your income level and filing status. The U.S. income tax is progressive, which means the more you earn, the higher your tax rate climbs. Income tax is withheld from your paycheck, but you might still owe more (or get a refund) when you file your tax return each year, since there are credits, deductions, and exemptions that can change what you owe.
So, in short: payroll taxes are flat rates for specific programs and split between employer and employee, while income taxes are based on your overall income, have different brackets, and are paid by individuals.
Payroll Taxes vs. Income Taxes: How Do You Calculate?
When a company pays its employees, it’s not just about the gross salary agreed upon. A significant part of the payroll process involves calculating and withholding various taxes, which included payroll and income taxes.
How Do You Calculate Payroll Tax?
Before you even start crunching numbers for payroll tax, there are a few things you need to have in order. First, you’ll want to know exactly which employees are on your payroll and whether they’re classified correctly — are they full-time, part-time, or independent contractors? That matters, because payroll taxes only apply to employees, not contractors. Next, you’ll need each employee’s gross wages, which includes their salary, hourly pay, overtime, and even certain bonuses.
Once you’ve got all that info, check the current tax rates for Social Security and Medicare (those are the two main federal payroll taxes in the U.S.), as well as any state or local payroll taxes that might apply. Don’t forget about things like unemployment taxes, which employers pay separately.
To actually calculate payroll tax:
- Figure out each employee’s gross pay for the period.
- Multiply the gross pay by the Social Security and Medicare tax rates. For 2025, that’s 6.2% for Social Security (up to a wage limit) and 1.45% for Medicare, with an extra 0.9% Medicare tax for higher earners.
- Add in any state or local payroll taxes as needed.
- Make sure you’re calculating both the employee and employer portions, since employers match the Social Security and Medicare taxes.
If you’re doing this manually, double-check your math. Most businesses use payroll software or a payroll service to handle the calculations and filings, which helps avoid costly mistakes.
Payroll Tax Calculation Example
If an employee makes $1,000 per pay period, the following are simple calculations:
- Social Security rate is 6.2% for employer and employee
- $1,000 × 6.2% = $62 (employee) and $62 (employer match)
- Medicare rate is 1.45% for employer and employee
- $1,000 x 1.45% = $14.50 (employee) and $14.50 (employer match)
- Total employee payroll tax deduction: $76.50, with the employer also paying $76.50 for that employee.
How Do You Calculate Income Tax?
Income tax calculations are more complex, requiring you to reference IRS tax tables and consider the employee’s W-4 information including filing status, dependents, and additional withholding requests.
To actually calculate income tax for an employee, here’s what you need to do:
- Gather the employee’s completed W-4 form. This tells you their filing status (like Single or Married), how many dependents they’re claiming, and if they’ve requested any extra withholding.
- Determine the employee’s gross pay for the pay period.
- Reduce the gross pay by any pre-tax deductions (like contributions to retirement plans or health insurance), since these lower the amount of income subject to tax.
- Use the IRS income tax withholding tables (typically found in IRS Publication 15-T) to figure out the amount to withhold. You’ll reference the employee’s wage level, pay frequency (weekly, biweekly, etc.), and W-4 info to find the right row and column in the tables.
- Adjust the withholding for any extra amounts requested on the employee’s W-4.
- Withhold the calculated amount from the employee’s paycheck and send it to the IRS along with your payroll tax filings.
It’s a good idea to use payroll software for this, since the tables and rules can change each year, and it’s easy to make mistakes if you’re doing it by hand.
Income Tax Calculation Example
A full-time employee in Ohio with a gross annual income of $40,000 per year whose filing status is Single, doesn’t have multiple jobs, other income sources, children to claim as dependents, and any other withholding requests would have a calculation as follows for their income tax:
- Starting with $40,000, you apply the standard deduction for a filing status of Single, which in 2024 was $14,600.
- So, gross income minus standard deduction ($40,000 – $14,600) leaves an adjusted gross income of $25,400.
- The federal tax system is progressive, so different parts of income are taxed at different rates:
- The first $11,600 is taxed at 10% ($11,600 x 0.10 = $1,160)
- The remaining income ($25,400 – $11,600) is taxed at 12% ($13,800 x 0.12 = $1,656)
- Total annual federal income tax is $2,816
Similarities Between Payroll Taxes and Income Taxes
Despite their differences, payroll and income taxes share important similarities:
Mandatory Withholding
Each type of tax must be deducted from employee paychecks, which reduces take-home pay.
Employer Responsibility
As an employer, you must accurately calculate and withhold payroll and income taxes from employees and properly remit them to the appropriate government agencies, including the IRS and state revenue agencies.
Compliance Requirements
Failure to properly handle any of these taxes (withholding and remittance) may result in significant penalties from the IRS.
How Paycor Helps with Payroll and Income Taxes
Navigating the complexities of tax compliance can be a significant burden for any business owner. Errors can lead to audits, penalties, and a great deal of stress. Paycor’s HCM software is designed to simplify and automate this process.
Our platform helps ensure accurate and timely tax filings, giving you peace of mind and freeing up your time to focus on your business. With Paycor, you can easily manage payroll taxes and income taxes from a single, intuitive platform.
Manage Your Payroll Taxes and Income Taxes with Paycor
Don’t let tax compliance overwhelm you. With Paycor, you can automate your tax calculations and filings, receive proactive compliance alerts, and streamline your entire payroll process. Our payroll software is built to help you save time, reduce errors, and stay compliant with ever-changing tax laws.
Take a guided tour today to learn more.
Payroll Taxes and Income Taxes FAQs
Still seeking answers to your questions about payroll and income taxes? Read on.
Who is Exempt from Payroll Tax?
The most common exemption from payroll taxes is for independent contractors and freelancers. Employers are not required to withhold federal income taxes or FICA (Social Security and Medicare) from the wages of independent contractors. These workers are responsible for paying their own taxes directly to the appropriate government agencies.
Do Employees Pay More Payroll or Income Taxes?
It’s not uncommon for payroll taxes to feel like a heavier burden for many households. This is because payroll taxes are regressive, meaning that as you earn more, the percentage of your salary paid in payroll tax decreases due to income caps on Social Security. In contrast, income taxes are progressive, so the more you earn, the higher the percentage of your salary you’ll pay in taxes.
Are Income and Payroll Taxes Paid the Same Way?
Both income and payroll taxes are generally paid through withholding by the employer. Employers are legally required to deduct these taxes from an employee’s paycheck and submit them to the government. The key difference is that payroll taxes are paid by both the employer and the employee, while income taxes are only paid by the employee.
How Do Payroll Taxes vs. Income Taxes Impact Employees?
For payroll taxes, which fund government programs such as Social Security and Medicare, the impact depends upon the individual and their specific circumstances in life. As for income taxes that fund a range of government spending and public services such as infrastructure (roads and bridges) and national defense, the impact is ever-present.
Do All States Require Payroll Tax and Income Tax Withholding?
Not all states require withholding for income tax. Nine states do not have a state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. However, every state has a state-level unemployment insurance tax, which is considered a payroll tax. Some states may also have other payroll taxes for things like paid family leave or disability insurance.
What Are the Differences Between Payroll tax vs income Tax Rates?
While both taxes reduce take-home pay, they serve different purposes. Payroll taxes directly contribute to benefits employees may receive from Social Security and Medicare, while income taxes support general government services.