Payroll Taxes vs. Income Taxes: An Overview
CAVU HCM is here to help make your payroll process the simplest it can be while giving you time and money back. We know that payroll tax vs. income tax can easily become complicated. That's why we've created options to discover the difference between payroll and income tax or leave it up to experts like our team and software to do payroll for you.
- What is payroll tax?
- How is payroll tax calculated?
- What is income tax?
- How is income tax calculated?
- What are the main differences between payroll and income tax?
- Other FAQ
What is payroll tax?
Payroll tax, also known as an employment tax, is a certain percentage withheld from employee wages, to pay the government on the employee’s behalf. Payroll tax is made up of payments for medicare, social security, and unemployment. The federal and state tax agencies take these payments and create with these payments which then allows these benefits to be paid to individuals. You'll often see this listed as FICA, which stands for the federal insurance contributions act. The federal payroll tax that funds social security and medicare is labeled FICA and MedFICA on paychecks. FICA is paid by both employee and employer, while the employer also pays the unemployment benefits tax.
How is Payroll Tax Calculated?
A payroll tax is a flat-rate tax. To calculate the exact amount you'll be withholding for payroll taxes:
1. Calculate gross pay and wage
Because payroll tax is dependent on the amount your employee makes. First, you must figure out the gross wages and income. Any salary over $142,800 in 2021 has a different calculation for FICA taxes, so knowing this is needed for the following steps.
2. Calculate FICA
FICA is a portion taken out of every paycheck. FICA consists of payments for social security tax and medicare. Social security tax is a set percentage of 6.2%. However, for any employee making more than $142,800, their social security contribution would be capped at $8,853.60
Medicare is a flat tax of 1.45% of gross pay. Medicare does not have a cap, in fact, employees that make more than $200,000 have an additional medicare tax of .9%. This depends on filing status, the $200,000 figure is for single or HOH filer.
The total FICA tax is both the social security and medicare tax added together.
Match FICAIn addition to the employee's portion, every employer is expected to match the employee's FICA amount. Meaning you’ll take the FICA calculation you did above and pay that same portion for taxes.
Calculate federal and state unemployment taxesBefore you tally up your total, you will also want to calculate the unemployment tax, which includes both federal and state taxes. The federal unemployment tax (FUTA) is .6% of the first $7,000 of wages. Then the rate changes depending on if your state requires unemployment tax. State unemployment tax can be found from your state's department of labor. FUTA is really 0.6% after the FUTA credit, currently, all 50 states pay FUTA at 0.6% of the first $7000 in wages
Determine tax depositThe total added up from FICA, employer-matched FICA, and unemployment tax is your payroll tax.
What is Income Tax?
Income tax is a tax on income by the government that exists for both businesses and individuals. An income tax is used for a general fund for the government. This fund is used for things like public services and public programs, and depending on the state, for state government as well. These withholdings contribute to local, state, and federal income tax requirements.
How is Income Tax Calculated?
Income tax will depend on what kind of business you are, how much your business earns, and how much income your employees earn. These factors will all determine your tax rate.
Whether it's self-employment, LLC, a corporation, etc., the status of your business will impact your taxable income. To learn more about what the tax income is for your type of business and your earnings, check out the IRS guide here (page 6). For example, if you are self-employed vs. have an LLC or a corporation, your federal income tax will change. Here is a quick guide to the forms you’ll want to file for income tax:
- Sole proprietor: 1040, or 1040-SR and schedule C1
- Partnership: 1065
- Partnership in a partnership: 1065
- C corporation or S Corporation: 1120 (C corp), 1120 (S Corp)
- S corporation shareholder: 1040, or 1040 SR, and Schedule E
Self-employed or have a small team? Our team specializes in payroll for businesses of all sizes.
Sole proprietors, partners, and S corp shareholders generally make estimated payments (if you expect to owe more than $1000). While corporations generally make estimated payments (if you expect to owe more than $500.)
The other main consideration is what your local income taxes/ state income taxes are. Every state has a slightly different state income tax, and that can impact what you withhold. Find your state income tax here.
How do you calculate how much to withhold from income tax?
For all businesses with employees, you generally must withhold income taxes. The first thing you'll want to have on hand is your employee's form W-4 to assess their filing status to calculate employee income tax. There are two common ways to calculate income tax, either with a wage bracket or a percentage method. If you are looking to avoid getting into the nitty-gritty details, you can also check out the IRS calculator.
With the wage bracket method, you will take a look at their form W-4 and how they filled, and the employee's wage to determine their income tax. Find your federal income tax through IRS’s wage bracket here (page 15).
With the percentage method, you'll also use their filing status and wages. The difference of percentage method is often of preference, or salary range. Any employee income past $100,000 can use the percentage method to calculate the proper withholdings. Find your federal income tax through the IRS's percentage method tables here (page 51). Publication 583 (Rev. January 2021)
If you still feel unclear about the exact amount to withhold for employees and employers, we are here to help. We can help you calculate the exact amount you should withhold, how much employees should be paid and their wages, and what your federal, state, and local taxes are.
What are the Main Differences between Payroll Tax and Income Tax?
Payroll taxes and withholding taxes can be easily confused since they are both taken out of an employee paycheck by the employer. The main difference between payroll tax and income is payroll taxes are taxes used for specific programs, such as medicare, social security, and unemployment. In contrast, income taxes are just a general fund to the U.S Treasury. The other main difference are the amounts employers take out. A payroll tax is a set rate for every income (with some exceptions depending on employee wages, see above!). While income taxes are progressive taxes, meaning the amount paid changes depending on income level.
It's important to understand the differences between payroll tax and income to ensure you are paying the correct total federal tax and state tax amounts. All together, payroll tax and withholding for income tax are what is withheld from every paycheck.
Frequently asked questions
What is the last date for filing an income tax return?
Is it illegal not to pay payroll taxes?
Yes, not paying employment taxes may subject you to criminal and civil sanctions as well as financial penalties. Also, when employees and employers are not withholding the correct amount, they are impacting the benefits and programs created to support people. It is illegal to not pay income taxes as well.
Payroll and income tax is defined by local, state, and federal mandates, such as the Federal Insurance Contributions Act.
How can I avoid paying payroll taxes?
There is no way to avoid payroll taxes altogether. However, there are ways to decrease payroll taxes. For example, you may want to consider using accountable plans, paying benefits exempt from payroll, or paying corporate directors. Or you can find a payroll provider like us that offers tax credit services and is constantly looking for payroll tax credits for your business, allowing you to have a higher ROI on your payroll and tax services.
It is illegal, however, to not withhold the appropriate sums for income taxes.
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