Payroll Tax vs. Income Tax

Navigating payroll tax vs. income tax is crucial to managing your business's tax obligations. As an employer, you're responsible for both these mandatory withholdings, but each is a separate tax deduction that serves a distinct purpose in your payroll process. Make sure you understand both income tax and payroll tax, how they compare, how to calculate each, and how to properly meet employer responsibilities for these taxes.

What Is the Difference Between Payroll Tax and Income Tax?

Payroll and income taxes serve different purposes in the tax system, with one key distinction setting them apart: payroll taxes are split between employers and employees, while income taxes fall solely on employees' shoulders.

Use the chart below to learn how payroll taxes are different from personal income taxes: see who pays them, how they're calculated, and where the money goes.

What Are Income Taxes?

The income tax definition says they are withholdings from your employees' paychecks to cover their federal tax obligations for the year. When considering wage tax vs. income tax, the actual amount that's withheld is based on information each employee provides on their Form W-4, which they complete when you hire them. This form captures key details used to determine how much is income tax — like their marital status, whether additional withholding should be made to cover certain personal taxes, and whether they may be entitled to deductions that would reduce their income taxes (e.g., claiming dependents may make them eligible for tax credits).

Most states require employers to withhold state income tax from employees' paychecks, with a few exceptions. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming don't have state income tax requirements. In some cities, like New York City and Denver, you'll also need to handle local income tax withholdings. Get a full breakdown of payroll taxes by reading our payroll tax guide for employers.

Who Pays Income Taxes?

Your employees are responsible for paying and reporting these taxes on their annual tax returns. As an employer, your role is to manage the withholdings, making sure the correct amount is deducted from their paychecks each pay period.

For self-employed workers, it works differently. If you fall into this category, you must take care of all your tax obligations on your own, including filing annual returns and paying estimated taxes quarterly to cover both your self-employment (SE) tax and income tax. These taxes aren't automatically withheld from wages the same way as with W-2 employment.

How To Calculate Income Tax

Knowing how to calculate income tax first requires understanding how the system is set up. The federal income tax definition isn't as straightforward as a single flat rate. Instead, the U.S. uses what's called a progressive system — as someone's income moves into higher tax brackets, only the portion in that bracket gets taxed at the higher rate. These brackets shift based on filing status (e.g., single, married filing jointly, married filing separately, head of household).

State and local income taxes vary by location. Each state and locality sets its rates, which could be flat, progressive, or even a specific dollar amount. For example, New York City residents can pay up to 3.876% in additional taxes to the city, while Denver has an occupational privilege tax (OPT) that's $9.75 per month.

To determine how to calculate federal income tax and how much to withhold, here's what you'll need to do:

• Refer to the withholding tables in IRS Publication 15T, or Circular E.
• Choose between the wage bracket method or percentage method, which the IRS uses to calculate federal income tax withholding.
• Gather information such as pay frequency, each employee's total earnings for the pay period, and Form W-4 details.
• Account for any employees exempt from federal withholding.

While you can follow these steps to calculate income tax on your own each pay period, you can also simplify the process with help from a payroll service, which automatically calculates federal income tax withholding each time you run payroll.

Income Tax Example

Let's make this easier to understand with a real-world example. Meet Taylor, who's single and earns $50,000 in taxable income for the year. Based on IRS tax rates, you might think Taylor pays 22% on all that income — but that's not how it works. Instead, under a progressive tax system, Taylor pays 10% on the first bracket, 12% on the income in the second bracket, and 22% on the income in the third bracket.

The math looks like this:

• The first $11,925 is taxed at 10% = $1,193; plus
• The next portion up to $48,475 is taxed at 12% = $4,386; plus
• The remaining amount is taxed at 22% = $336
• Total federal income tax = $5,915

What Are Payroll Taxes?

The payroll tax definition explains that payroll taxes are federal and state taxes taken from an employee's taxable compensation. They are distinct from income taxes. The payroll tax meaning includes federal and state taxes on an employee's taxable compensation that help the government support social programs (e.g., Social Security and Medicare for retired or disabled individuals).

FUTA is the federal tax that supports unemployment benefits and helps pay wages to those who have lost their jobs. It is included in the definition of payroll tax as the withholding amount determined by what employees indicate on their W-4 form when hired.

Payroll taxes include:

• Income tax withholding, based on information provided by employees on Form W-4. As mentioned earlier, this tax is paid entirely by employees.
• Federal Insurance Contributions Act (FICA) tax, meaning Social Security and Medicare taxes combined. The Social Security portion, defined as Old Age, Survivors, and Disability Insurance (OASDI), funds benefits to retirees, certain family members, and individuals with disabilities. Medicare taxes allow coverage under Part A with no additional cost for those age 65 and older (or eligible individuals), with optional coverage through Parts B, C, and D available for an additional premium.
• FUTA, which is defined as the federal unemployment tax paid only by employers.
• State unemployment tax and SUTA programs are primarily employer-paid taxes, though some states also require state unemployment tax contributions from employees.
• State and local income taxes are additional withholdings required by most states and some cities to fund state and local government programs. Each location defines the rates and requirements differently, with some states having no income tax at all.

Learn more about the different types of payroll taxes.

Who Pays Payroll Taxes?

Most payroll taxes, such as FICA, are a team effort, with you and your employees covering the cost. FUTA contributions are different, as you pay them entirely as the employer. SUTA and state unemployment programs are usually funded via employer tax.

For self-employed individuals, the answer to "Is payroll tax the same as income tax?" isn't quite so straightforward. When you're self-employed, payroll tax is the same as income tax: Contractors and the self-employed are responsible for managing tax obligations independently. If you hire them, your business isn't accountable for any employment taxes on payments made to them. The self-employment tax these individuals pay on their net earnings is essentially the employee and employer share of FICA.

How To Calculate Payroll Tax

Calculating payroll tax withholding starts with examining your employee's W-4 form and the information on their salary and deductions. To know how much is payroll tax, you must understand that rates are set each year:

• Social Security: You and your employee contribute 6.2% each, but this contribution only applies to the first $176,100 in wages for the 2025 tax year.
• Medicare: You'll each contribute 1.45%. Once an employee's wages exceed $200,000 for the year, you'll withhold an additional 0.9%.
• FUTA: As an employer, you'll pay 6% on the first $7,000 of each employee's yearly wages. Employers can get a credit of up to 5.4% for state unemployment tax, bringing the net federal rate down to 0.6% (i.e., a maximum FUTA payment of $42 per employee).
• SUI/SUTA: These rates and wage bases vary depending on the state in which your employee resides. New employers often pay a flat rate for the first few years before moving to a rated schedule based on your contributions to the state's unemployment fund.

Payroll Tax Example

Let's stick with our earlier example of Taylor, who makes $50,000 per year, to see how these payroll taxes work based on the tax rates outlined above. Payroll is processed bi-weekly, so here's how the payroll tax math breaks down for each paycheck:

• Wages per paycheck: $1,923 (gross)
• Social Security tax: $119 (6.2% of $1,923)
• Medicare tax: $27.88 (1.45% of $1,923)
• Total FICA taxes paid = $146.88

Remember that employers also shoulder some of the payroll tax responsibility. In this instance, the employer withholds the following amounts per paycheck:

• Social Security tax: $119 (6.2% of $1,923)
• Medicare tax: $27.88 (1.45% of $1,923)
• FUTA tax: $11.50 (0.6% of $1,923)
• SUTA tax: $52 (2.7% of $1,923)
• Total employer portion of payroll taxes = $210.38

In this example, the taxable wage base is $7,000. Once Taylor's gross wages exceed this amount, the employer no longer must pay FUTA or SUTA taxes for that year. 

Also, because Taylor's wages stay below both the Social Security limit ($176,100) and Medicare threshold ($200,000), the employer's FICA withholdings stay the same throughout the year.

Effective Strategies for Processing Payroll and Income Taxes

Getting income vs. payroll tax right requires laying the proper groundwork, starting with employee classification. Making sure each worker is appropriately categorized as an employee or an independent contractor directly affects the individual's income tax meaning and your tax withholding obligations as a business. Proper classification helps you avoid costly mistakes and withhold the correct amounts.

You must also maintain employee records for accurate payroll processing. Keep W-4 forms current, track voluntary deductions (e.g., retirement account contributions, health insurance premiums, etc.), and document employee pay rate and status changes. This information is essential for calculating withholding amounts and managing additional deductions like state taxes or court-ordered garnishments.

To stay compliant, set up a calendar for all your filing deadlines. You must complete each form according to its schedule — Form 941 for federal income and FICA taxes must be filed quarterly, Form 940 for the employer's FUTA tax return is due annually, and various state forms have their own requirements. Meeting these deadlines helps you avoid penalties and gives you time to review calculations for accuracy.

Knowing the Difference Between Payroll and Income Tax Is Critical

Employers' payroll tax responsibilities are extensive, and it's not always straightforward. When tax rules change, or questions come up about payroll taxes vs. income taxes, your obligations can feel overwhelming. Unfortunately, not knowing employment tax laws and deadlines won't protect you from potential penalties. Get tax expertise on your side and consider outsourcing to a payroll services provider.