Payroll taxes help fund Social Security and Medicare, and employers and employees share the cost. Income taxes, on the other hand, depend on how much you earn and go toward government expenses.
Plus, only employees pay them.
So, in simple terms, payroll taxes are split, while income taxes come straight out of your paycheck. Let’s break it down further.
The Basics of Payroll Taxes
As we have seen earlier, payroll taxes are mandatory deductions taken from an employee’s paycheck to fund programs like Social Security and Medicare.
These taxes are split between employers and employees, meaning both parties contribute.
For instance, let’s say you earn $4,000 per month. The payroll tax rate for Social Security is 6.2% for both the employee and employer, while Medicare is 1.45% each.
Here’s how much gets deducted:
⦿ Social Security Tax: $4,000 × 6.2% = $248 (you pay) + $248 (your employer pays)
⦿ Medicare Tax: $4,000 × 1.45% = $58 (you pay) + $58 (your employer pays)
Total payroll taxes deducted from your paycheck? $306. Your employer also pays the same amount, making the total contribution $612 toward these programs.
What If You’re Self-Employed?
If you work for yourself, there’s no employer to split the cost with. That means you’re responsible for both shares of payroll taxes. Instead of paying 7.65% (the combined employee rate), you pay:
⦿ Social Security: 12.4%
⦿ Medicare: 2.9%
That adds up to 15.3% of your income going toward payroll taxes. This is why self-employed individuals often need to plan carefully for tax payments.
The Essentials of Income Taxes
Unlike payroll taxes, income taxes are not split.
These are deducted from your wages based on your earnings and personal tax bracket. The money collected goes to federal and state governments for services like education, defense, and infrastructure.
Let’s take the same $4,000 per month salary. Suppose your income tax rate is 12% (this varies based on income and tax brackets). Your income tax deduction would be:
⦿ Income Tax Deduction: $4,000 × 12% = $480
Unlike payroll taxes, which have fixed rates, income taxes are progressive. The more you earn, the higher your tax rate.
Plus, different deductions, credits, and filing statuses can lower what you owe.
Key Differences Between Payroll and Income Taxes
Smart Ways to Handle Income and Payroll Taxes
Taxes aren’t exciting, but smart strategies can make them easier. Here’s what helps.
1. Don’t Miss Tax Deadlines
The IRS takes late payments seriously.
If you file late, you’ll be hit with a Failure to File penalty of 5% of your unpaid taxes per month (up to 25%). If you don’t pay what you owe on time, there’s an additional Failure to Pay penalty of 0.5% per month.
Avoid these extra costs by setting reminders for important deadlines, like quarterly payroll tax filings (Form 941) and year-end forms (W-2s, and 1099s).
2. Keep Up with Tax Rates
Tax laws don’t stay the same forever. If you don’t keep up, you could end up owing more than expected. Or worse, underpaying and getting hit with penalties.
For 2024, the Social Security tax rate is still 6.2% for both employees and employers, and Medicare tax remains at 1.45% each. But if you make more than $200,000 as an individual (or $250,000 as a married couple), there’s an extra 0.9% Medicare tax to factor in.
Staying updated means no surprises when tax season rolls around.
3. Automate Payroll Taxes
Manually calculating payroll taxes is a gamble you don’t want to take. One small mistake can lead to costly fines. The best way to avoid this?
Use payroll software that automatically calculates withholdings, Social Security, Medicare, and unemployment taxes for you.
4. Set Tax Money Aside
A common mistake business owners and freelancers make is waiting until tax time to think about taxes. That’s a surefire way to end up short.
The fix? Set aside a percentage of your income in a separate account just for taxes.
For example, if you owe $5,000 in payroll taxes each month, keeping that money untouched means you won’t be scrambling when it’s time to pay up.
If you’re a freelancer or gig worker, aim to save 25-30% of your earnings for taxes.
5. Use Tax Deductions and Credits to Pay Less
Why pay more taxes than necessary?
Businesses can lower their tax bill with credits like the Work Opportunity Tax Credit (WOTC), which rewards companies for hiring veterans and underrepresented workers.
If you provide health insurance for employees, you might qualify for the Small Business Health Care Tax Credit. And for individuals, deductions like retirement contributions, student loan interest, and mortgage interest can help reduce taxable income.
6. Hire a Tax Pro
Sure, you can try to handle everything yourself, but tax laws are complex, and missing a key deduction or filing mistake can cost you.
A Certified Public Accountant (CPA) or Enrolled Agent (EA) can help you maximize deductions, handle audits, and save money in the long run.
7. Keep Good Records
Tax season is a lot easier when your paperwork is in order. The IRS recommends keeping payroll records, tax filings, and employee tax forms for at least four years.
Going digital makes this much easier.
8. Adjust Your Tax Withholding or Estimated Payments When Needed
If your financial situation changes, like getting a raise, starting a side hustle, or switching jobs, you’ll want to review your W-4 form.
That is to make sure you’re not underpaying (or overpaying). Self-employed workers should also stay on top of quarterly estimated tax payments to avoid penalties.
The general rule?
If you expect to owe more than $1,000 in taxes for the year, you should be making estimated payments.
Tax Documents to Help You Stay on Track
Earlier, we talked about filing taxes, and to do that, you need the right forms. But which ones?
If you’re an employee, your employer will give you a W-2 form. This shows how much you earned and how much tax was taken out. Employers must send W-2s to employees (and the IRS) by January 31 each year.
If you’re a contractor or freelancer, you’ll get a 1099 form instead. Unlike employees, taxes aren’t taken out of your paycheck, so you use a 1099 to report your earnings and handle taxes yourself. Businesses that hire contractors must send out 1099-NEC forms by the same deadline.
Need to create these forms?
PaystubHero makes it easy. Whether you’re an employer handling payroll or a contractor needing proof of income, PaystubHero helps you generate W-2s, 1099s, and pay stubs quickly and accurately.
FAQs
Here are some common questions about the difference between payroll tax and income tax:
