As an employer, you are responsible for withholding taxes from employee wages. Employment taxes come out of each employee’s gross wages and can be broken down into payroll taxes and income taxes. Many people use the terms payroll taxes and income taxes interchangeably, but they are different. Learn about payroll tax vs. income tax here.
Income tax vs. payroll tax
Payroll tax and income tax are separate groups, but you need to know both in order to withhold employment taxes.
Payroll tax consists of Social Security and Medicare taxes, otherwise known as Federal Insurance Contributions Act (FICA) tax. FICA tax is an employer-employee tax, meaning both you and your employees will contribute to it.
Income tax is made up of federal, state, and local income taxes. Unless exempt, every employee pays federal income tax. Most states also have state income tax. Some localities have an additional local income tax as well.
After withholding taxes, you are required to deposit and report them to the IRS. Your depositing schedule will be the same for both payroll and income taxes. And, you will report them on the same form (Form 941 or Form 944). But, federal income taxes and payroll taxes have separate lines on the reporting form.
Payroll tax is a percentage that you withhold from employee wages. You must withhold 7.65% of each employee’s gross wages from their pay. And, you contribute a matching 7.65%.
So, if an employee earns $500 per paycheck, you will withhold $38.25 ($500 X .0765) from their paycheck. You also need to contribute $38.25.
Let’s break down the percentage by Social Security and Medicare.
Social Security tax is 6.2%. There is a Social Security wage base limit, so you only need to withhold up to a certain amount. When an employee earns $132,900 in 2019, you will stop withholding. And, you will stop paying the employer portion. The wage base for 2018 is $128,400.
Medicare tax is 1.45%. Unlike Social Security tax, there is no Medicare wage base limit. Instead, there is an Additional Medicare tax. After an employee earns $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately), you need to withhold an additional 0.9% of their wages. That means you will withhold 2.35% for Medicare with the additional tax. However, you only contribute 1.45%, as you do not owe the Additional Medicare tax.
You’re probably wondering — what is the purpose of payroll taxes? Payroll taxes fund Social Security and Medicare programs. This includes retirement, disability, health care, hospice care, and survivor of deceased worker benefits.
Income tax refers to federal, state, and local income taxes. Unlike payroll tax, income tax is not one flat rate.
On Form W-4, employees can enter an unlimited number of allowances. The more the employee claims, the less you withhold for federal income tax.
To determine how much to withhold for federal income tax, you must use IRS Publication 15. There are two tax withholding table methods—percentage and wage bracket. You will use the number of allowances on the employee’s Form W-4 as well as their weekly wages to figure out their federal income tax deduction.
State income tax works similarly to federal income tax. If there is state income tax, you will give your employee a state income tax withholding form. Employees can claim allowances from state income tax. Depending on your business’s location, you might pay local income tax.
Income taxes fund public services like defense, education, and transportation.
Things to keep in mind
Although payroll taxes and income taxes are not one in the same, you need to withhold both from your employees’ paychecks.
Doing payroll by hand is an option for deducting payroll and income taxes, but this can be time consuming and lead to mistakes. You can make payroll deductions easier by hiring an accountant or using payroll software.
You should distribute pay stubs to each employee. The pay stub should show the employee their gross wages, how much you withheld for payroll and income taxes, and their net pay.
Make payroll easier on yourself. Patriot’s online payroll software withholds deductions from employee wages. And, our payroll services option will deposit and file taxes for you. Try it for free today!
This is not intended as legal advice; for more information, please click here.