Payroll Tax vs. Income Tax: What Are the Differences?

Taxes are a core part of earning money in the United States. Every time you get paid, part of your paycheck goes toward federal taxes, specifically income tax and payroll taxes. These two types of taxes often get confused, but they serve different purposes and are handled in different ways.

Understanding the difference between payroll tax and income tax is key for anyone managing their finances, whether you’re an employee, employer, or self-employed. It also helps with staying on top of your tax obligations, reducing your tax burden, and improving tax compliance.

At BSI, we frequently get asked what the difference between payroll tax and income tax is. We’ll break down how federal income tax and payroll taxes are collected, how they’re used, and who pays them.

Key Takeaways

• Payroll taxes fund Social Security, Medicare, and unemployment programs, and are shared by employers and employees.
• Income taxes fund general government services and are paid by individuals and businesses based on total taxable income.
• Payroll taxes are applied at fixed rates, while income taxes use a progressive tax system based on filing status and income brackets.
• Employers are responsible for withholding and remitting both payroll and income taxes for their employees.
• Self-employed individuals must cover both the employee and employer portions of payroll taxes through self-employment tax.
• BSI offers payroll tax compliance solutions like TaxFactory™, TaxProfileFactory™, and ComplianceFactory™ to simplify calculations and reduce risk.

How Taxes Are Withheld From Paychecks

When you receive a paycheck, the amount you take home, called your net pay, is less than your total gross wages. That’s because multiple employment taxes are taken out before you’re paid. These include:

• Federal income tax withholding
• Social Security and Medicare taxes (FICA taxes)
• State income taxes, local income taxes, and unemployment taxes depending on where you live and work

These deductions are part of the payroll process and are usually calculated based on your filing status, pay period, and taxable income. Employers are required to withhold income taxes and calculate payroll taxes according to federal and state guidelines.

Employers also incur payroll expenses by matching some of the taxes taken out of your paycheck. For example, they match your FICA taxes, which include Social Security tax and Medicare tax. They also pay separate unemployment taxes like the FUTA tax (Federal Unemployment Tax Act) and SUTA taxes (State Unemployment Tax Act).

The Purpose Behind Each Tax Type

Payroll Tax: Funding Social Insurance Programs

Payroll taxes directly fund specific social insurance programs that many Americans rely on. These include:

• Social Security: Social security taxes provide a monthly payment to retired workers, people with disabilities, and the families of deceased workers. These benefits help cover living costs for people no longer able to work.
• Medicare: Funded by the Medicare tax, this program offers health care coverage for individuals aged 65 and older, as well as certain younger people with disabilities.
• Federal and State Unemployment Insurance: These programs offer unemployment benefits to people who lose their jobs through no fault of their own. They are funded by FUTA and SUTA taxes paid by employers.

Together, these security and Medicare taxes are part of the Federal Insurance Contributions Act (FICA) and represent a key piece of the income and payroll tax system in the U.S.

Income Tax: Funding Government Services

While payroll taxes fund specific programs, income taxes, including federal, state, and local income taxes, support general government operations. This includes:

• National defense and military funding
• Education and public schools
• Roadways, bridges, and transportation infrastructure
• Law enforcement, courts, and other civic systems
• Health insurance premiums for certain federal programs

Income taxes are a part of the progressive tax system, meaning your personal income tax rate increases as your income rises. These taxes are used for a wide range of services that benefit the public and are vital for maintaining essential functions of the federal and state governments.

Who Pays Each Type of Tax

Payroll Tax Payers

Payroll taxes are shared responsibilities:

• Employees paychecks are reduced by payroll taxes like FICA, which includes the Social Security tax and Medicare tax.
• Employers pay an equal amount toward these taxes, taking on half of the payroll tax responsibility.
• Self-employed individuals must pay the full amount themselves as self-employment tax, though they can deduct a portion for income tax purposes.
• Employers are solely responsible for federal unemployment tax (FUTA) and state unemployment taxes, which fund unemployment insurance programs.

This system means that both the employer and employee contribute to funding benefits like retirement, disability, and health care.

Income Tax Payers

Income tax is the responsibility of the individual or business earning money:

• Employers are required to estimate and withhold income taxes based on IRS formulas and your W-4 form.
• These estimates are based on your employee’s taxable compensation, retirement plan contributions, and any voluntary deductions you may have.
• At the end of the year, you must file your tax return, calculate your tax liability, and pay any balance due.

Your individual income tax can include federal, state, and sometimes local obligations. If you’re married filing jointly, your federal income tax rate may be different than if you were single, impacting the amount you owe.

Corporations also pay income tax, and all filers, business or personal, are expected to stay compliant with the IRS and their state agencies. You can work with a tax professional to make sure you meet all your responsibilities. Business owners or payroll managers can also simplify payroll tax compliance with solutions from BSI (that’s us!).

Income Sources for Income Tax

Now let’s talk about federal income tax. Unlike payroll tax, individual income tax reaches beyond earned wages. It includes:

• Wages and salaries
• Investment income like dividends and stocks
• Business profits
• Rental income

Basically, if it counts as taxable income for income tax purposes, it falls under the umbrella of federal income tax. That includes side hustles, real estate earnings, or even passive income from royalties. Here’s the nuance: while income and payroll tax both reduce your net pay, income taxes dig into a wider range of earnings.

So, if you’re receiving income beyond your job, income tax is what you’re dealing with. Oh, and don’t forget state income taxes, and local income taxes. These taxes differ from federal taxes but still shape your overall tax burden.

How Tax Rates Are Applied

Here’s where we dive into the actual numbers, and why payroll tax vs income tax isn’t just about what’s taxed, but how it’s taxed.

Payroll Tax Rates

Payroll tax rates are fixed and straightforward. In 2025, here’s the payroll tax example for employees:

• 6.2% for Social Security
• 1.45% for Medicare

Together, that’s 7.65% taken out of employee’s wages. Employers match this, making the total FICA obligation 15.3%. These are not negotiable percentages, everyone pays the same, regardless of income level. Employers also deal with state unemployment insurance and FUTA and SUTA taxes, important pieces of the wage tax landscape if you’re processing payroll.

Keep in mind: unlike income tax withholding, employees don’t have to calculate these themselves. But businesses? You’re responsible for every penny withheld and matched, so be careful not to miss a beat when processing payroll.

Income Tax Rates

Now here’s where things get interesting. The federal income tax rate system is a progressive tax system. That means:

• As your income increases, so does the rate you pay
• You fall into tax brackets based on your filing status, whether you’re single or married filing jointly, for example
• You don’t pay your top rate on all your income, just the portion within each bracket

So, if you earn $60,000, you’re not paying 22% on every dollar. Only the dollars that fall in that bracket get taxed at that rate. It’s more fair than it sounds, but also more complex.

Want to calculate income tax accurately? You’ll need to factor in things like retirement plan contributions, health insurance premiums, voluntary deductions, and taxes paid through federal income tax withholding throughout the year.

How the Taxes Are Filed

Understanding payroll tax and income tax differences also means understanding how each one gets filed. Spoiler: it’s not the same process.

Payroll Tax Filing

Good news first. If you’re an employee, you don’t have to file payroll taxes. Your employer handles that through regular withholding. Every time you get paid, they:

• Withhold income taxes and payroll taxes from your check
• Match the appropriate Social Security and Medicare tax
• Remit everything to the federal government

It’s baked into the payroll process. Your only job? Check your pay stub to make sure your net pay reflects what was withheld. That includes income tax withholding and FICA taxes.

For employers, though, this part gets tricky. You’ve got to pay payroll taxes, keep track of employment taxes, and make sure you’re up to date with FUTA, SUTA, and any state payroll taxes. Fall behind, and the IRS doesn’t play nice.

Income Tax Filing

This one’s on you. Every individual must file a federal income tax return, usually by April 15. That means:

1. Collecting all your income info from jobs, investments, and side gigs
2. Reporting it all on IRS Form 1040
3. Submitting any additional schedules based on deductions or credits
4. Comparing what you already paid (via withholding or quarterly estimates) to what you actually owe

If you pay income tax through your paycheck, you might get a refund. If not, it’s time to cut a check. And remember, if you underpaid throughout the year? Expect penalties. Business owners, freelancers, and landlords should stay ahead by planning quarterly payments, because with income and payroll tax, the timing matters just as much as the amount.

Summary Chart: Payroll Tax vs Income Tax

To keep things simple, here’s a visual payroll tax vs income breakdown. Bookmark it. Screenshot it. Use it the next time you’re reviewing employees’ paychecks or prepping your payroll process.

Simplify Payroll and Tax Compliance with BSI’s Trusted Solutions

At BSI, we help business owners, HR teams, and payroll managers streamline payroll and tax compliance with proven tools that do the heavy lifting for you. Our powerful suite of tools – TaxFactory™, TaxProfile™ Factory, and ComplianceFactory™ – takes the complexity out of payroll tax calculations, jurisdictional compliance, and employee tax profile management.

Whether you’re handling multi-state payroll or just trying to stay current with evolving regulations, our scalable solutions are designed to reduce risk, save time, and increase accuracy. Let us help you simplify the payroll process, minimize tax liability, and improve payroll confidence.

Have questions or are ready to make your payroll process easier? Contact us today to learn how BSI can support your payroll compliance needs.

Understanding The Difference Between Income Tax And Payroll Tax

By understanding the differences between payroll tax and income tax, you’ll have a clearer picture of how much you actually earn, what you’re paying for, and how to better manage your money. Whether you’re focused on processing payroll, learning how to pay taxes, or trying to make sense of tax rates, knowing the role of payroll and income tax is essential for financial confidence.

Whether you’re trying to calculate payroll taxes for your staff or pay taxes as a sole proprietor, knowing where each dollar is going, and why, helps you navigate the ever-changing landscape of federal and state tax rules and regulations. And if you’re in doubt? Don’t wing it. Reach out to our team at BSI for a simple solution for payroll tax calculations and compliance.

Disclaimer: The information provided in this article is for informational purposes only and should not be considered accounting, tax, or payroll advice. Always consult a qualified professional for guidance specific to your business or situation.