Payroll Tax vs. Income Tax: What Employers Need To Know

Knowing the difference between payroll and income tax is essential if your small business employs even just one person. It’s crucial for maintaining compliance and avoiding errors. The terms "payroll tax" and "income tax" are often used interchangeably, even though they're not identical.

Income tax is a component of the broader payroll deduction process. It differs from payroll taxes in specific ways. This guide will help you understand the difference between the two so you can get back to what you do best, supporting your people and growing your business.

What are Payroll Taxes?

Payroll taxes are deductions taken from an employee’s paycheck by the employer, including federal, state, and local income taxes and Social Security and Medicare taxes. Note that these tax requirements apply only to W-2 employees, not 1099 contractors.

• Federal Insurance Contributions Act (FICA): These taxes support Social Security and Medicare.

• Federal Unemployment Tax (FUTA): These taxes fund the federal unemployment programs, which provide financial assistance to workers who have lost their jobs.

• State Unemployment Tax (SUTA): Often referred to as State Unemployment Insurance (SUI), these taxes fund state-specific unemployment benefits. While SUTA taxes are mandatory for employers, some states require that employees contribute to their state unemployment programs.

What are Income Taxes?

Income taxes are primarily federal and state requirements. They are part of the overall deductions taken each pay period based on the employee’s specific earned income.

• Federal Income Tax: It is imposed by the U.S. Federal Government and is based on taxable income. Federal income tax must be withheld from all taxable income, including wages, salaries, commissions, and bonuses. The amount withheld varies for each employee, depending on their filing status, exemptions, income bracket, and tax credits.

• State Income Tax: Collected by individual U.S. states, this is similar to federal income tax in that it’s typically calculated based on taxable income after deductions and credits. The revenue from state income tax helps fund state-level programs and services, including education, transportation, and public safety. However, it’s important to note that not all states impose an income tax.

• Additional City or Municipal Taxes: Some locations require the withholding of additional income taxes from each paycheck, depending on local regulations. Cities, counties, or municipalities impose these income taxes, typically using the revenue to fund local services.

What's the Difference Between Payroll Tax and Income Tax?

While payroll and income taxes are the employer’s responsibility to calculate and withhold from each paycheck, there are four primary distinctions between payroll and income taxes.

1. Who Pays Taxes

One of the primary differences between payroll income tax and regular income tax is who is responsible for paying the tax.

• FICA stands for Federal Insurance Contributions Act, and it is a federal law that requires employers to withhold three separate taxes from their employee' paychecks: Social Security tax, Medicare tax, and Additional Medicare tax.

• FUTA taxes are paid only by employers, while SUTA taxes are mandated for all employers and, in some states, also for employees, making these a crucial part of employer payroll responsibilities.

• Employees pay federal and state income taxes.

• Local taxes depend on specific state level regulations.

2. How Taxes are Calculated

Calculating taxes can be a complex task. The calculation methods for payroll tax vs income tax differ as well.

• Payroll Taxes: Employees and employers share FICA taxes equally at a flat rate, each splitting the total contribution requirement on a per-check basis. The total contribution for Social Security tax is 12.4%, with both the employee and employer contributing 6.2%. For Medicare, the total requirement is 2.9%, with each party contributing 1.45%.

• Income Taxes: The rate for income taxes varies based on the employee’s specific income circumstances. The withholding amount is determined by the information on their Form W-4, which is completed during onboarding. This form includes details such as whether the employee is filing jointly or individually, as well as exemptions, tax credits, and other factors. Additionally, federal income tax is progressive, meaning the more an employee earns, the higher their tax rate.

3. Wage Thresholds

Keeping track of wage thresholds is crucial to accurately managing payroll for your entire team.

• Payroll Taxes: With FICA taxes, specific wage bases or thresholds can affect contribution amounts. The Social Security Tax has a wage base of $176,100 (as of 2025), meaning that employer and employee contributions stop once the employee reaches this amount in earnings. For Medicare, single employees earning over $200,000 in the calendar year must pay an additional Medicare Tax of 0.9%. The employer, however, is not responsible for this added tax.

• Income Taxes: For federal and state income taxes, there is no wage cap for employees. However, if an employee earns more than they did in the previous year, they may move into a higher tax bracket and be subject to a different tax rate.

4. How Taxes are Filed

Calculating and withholding taxes is only one part of the process. The method of filing these taxes also varies depending on the type of tax.

• Payroll Taxes: The employer is responsible for withholding and submitting these taxes on a scheduled basis. Here are the key forms and their purposes:

  • Form 941: Also known as the Employer's Quarterly Federal Tax Return, this form is used to report the Social Security and Medicare taxes withheld from employees’ paychecks. It's also used to pay your portion of the Social Security and Medicare taxes. Form 941 is filed every quarter.

  • Form 940: Known as the Employer's Annual Federal Unemployment Tax Return, this form is used to report your FUTA taxes for the year.

  • SUTA: Since each state manages its taxes, you must file the appropriate forms with the relevant agency. Typically, SUTA taxes are due quarterly, but deadlines vary by state.

• Income Taxes: You’re responsible for withholding and submitting federal, state, and any local taxes from your employees' paychecks based on the information on their W-4 forms. The filing process is similar to that of payroll taxes, with some minor differences:

  • Federal Income Taxes: You report and pay withheld income taxes using the same Form 941 as your FICA tax reporting. These taxes are typically due monthly or quarterly, depending on your filing schedule.

  • State and Local Income Taxes: Like tax rates, the filing requirements for state and local income taxes vary by location.

As an employer, you handle payroll taxes (such as FICA, FUTA, and SUTA) while also acting as a withholding agent for the employees’ income taxes by submitting them to the IRS and relevant state agencies. However, the employee remains responsible for filing their own annual income tax returns at the end of the year to reconcile any differences between the taxes withheld and their actual tax liability.

How Justworks Can Help

While understanding the difference between payroll and income tax can seem daunting, Justworks handles withholding, reporting, and remitting your payroll deductions while ensuring you remain compliant with up-to-date tax rates, regulations, and wage threshold tracking. We also offer multi-state compliance support, enabling you to focus on managing your team rather than navigating employment regulations across multiple states and countries.

Ready to learn more about how we can help you with your employer payroll responsibilities, freeing up your time to focus on growing your team and expanding your small business globally? Contact Justworks today to get started.