What Is the Difference Between Income and Payroll Tax?

Taxes are a fundamental aspect of financial life, funding government and public services. Income tax and payroll tax are two primary types most individuals encounter. While both involve money from earnings, they serve distinct purposes and are collected differently. Understanding these differences is important for personal finances.

Understanding Income Tax

Income tax is a levy imposed by federal, state, and some local governments on an individual’s or entity’s earnings. It applies to a broad range of income sources, including wages, salaries, tips, and self-employment earnings. Investment income, such as interest, dividends, and capital gains, is also subject to income tax. Rental income and other forms of compensation also fall under taxable income.

Both individuals and corporations are subject to income tax. For individuals, the U.S. employs a progressive tax system, taxing higher income levels at higher rates. Taxable income is categorized into different tax brackets, each with a corresponding marginal tax rate. Taxpayers can reduce their taxable income through deductions, like the standard deduction or itemized deductions, and through credits, which directly reduce the tax owed.

Income tax is primarily collected through employer withholding from paychecks, using information from an employee’s Form W-4. Self-employed individuals and those with significant income not subject to withholding typically make estimated tax payments quarterly. All taxpayers must file an annual tax return, such as Form 1040, by a specified deadline, usually April 15th, to report income and calculate their final tax liability or claim a refund.

Income tax primarily funds government operations and public services. Revenue supports national defense, education, infrastructure, public health, and social welfare programs. Unlike some other taxes, income tax revenue generally goes into a general fund, allocated across numerous government functions by legislative bodies.

Understanding Payroll Tax

Payroll tax refers to taxes withheld from an employee’s gross pay or paid directly by employers based on employee wages. These taxes fund social insurance programs. Main types include Social Security and Medicare (FICA taxes), Federal Unemployment Tax Act (FUTA) taxes, and State Unemployment Tax Act (SUTA) taxes.

Social Security and Medicare taxes are the primary components of FICA. Social Security funds retirement, disability, and survivor benefits for eligible individuals and their families. The Social Security tax rate is 6.2% for both employees and employers, applied to wages up to an annual limit. Medicare tax, which funds hospital insurance for the elderly and disabled, has a rate of 1.45% for both employees and employers, applied to all wages without a limit. Some high-income earners may also pay an additional Medicare tax of 0.9% on wages exceeding certain thresholds.

Federal Unemployment Tax Act (FUTA) provides funds for unemployment compensation benefits. The FUTA tax rate applies to the first $7,000 of an employee’s wages, though employers can often claim a credit for timely state unemployment tax payments, reducing the effective federal rate. This tax is paid solely by employers and is not withheld from employee paychecks. State Unemployment Tax Act (SUTA) taxes also fund unemployment benefits and are levied by individual states. SUTA rates and wage bases vary by state and employer history, with some states requiring employee contributions, though employer contributions are more common.

Payroll taxes are collected through direct employer withholding. Employers calculate and remit FICA taxes (employee and employer portions) to the IRS. FUTA taxes are also remitted by employers to the IRS. Remittances typically occur on a regular schedule, such as weekly, bi-weekly, or monthly, depending on tax liability.

Payroll taxes specifically fund designated social insurance programs. Unlike income taxes, these funds are earmarked for Social Security, Medicare, and unemployment benefits. This direct link ensures a dedicated funding source for programs providing a safety net for workers and their families in circumstances like retirement, disability, or job loss.

Key Distinctions

The fundamental differences between income tax and payroll tax lie in their purpose, tax base, and collection methods. Income tax revenue supports general government operations, while payroll taxes are specifically earmarked for social insurance programs like Social Security, Medicare, and unemployment benefits. Income tax applies to a broad range of earnings, including wages, investments, and rental income, whereas payroll taxes are levied primarily on wages and salaries from employment. Income tax is paid by individuals and corporations, often through withholding, estimated payments, and annual returns. Payroll taxes, particularly FICA, are shared between employees and employers and are primarily collected through employer withholding from paychecks.

References

Internal Revenue Service. “Topic No. 751 Social Security and Medicare Withholding Rates.” Accessed August 2, 2025.
Internal Revenue Service. “Topic No. 759 Federal Unemployment Tax (FUTA).” Accessed August 2, 2025.