What Is the Difference Between Income Tax and Payroll Tax?

Taxes are a core component of the U.S. economic system, funding public expenditures through mandatory contributions from individuals and corporations. Understanding different tax types is crucial, as they directly impact personal income and government services. Income tax and payroll tax are two primary categories affecting most working Americans, each serving distinct purposes and operating under different structures.

Income Tax Fundamentals

Income tax is a levy imposed by federal, most state, and some local governments on an individual’s or entity’s earnings. This tax applies to a broad range of income sources. Taxable income includes wages, salaries, bonuses, and tips, typically reported on a Form W-2. Investment income like dividends, interest, and capital gains are also subject to income tax. Business profits, rental income, and certain retirement distributions also contribute to taxable income.

Federal income tax calculation begins with gross income. Adjustments are made to arrive at adjusted gross income (AGI). Taxable income is then determined by subtracting either the standard or itemized deductions from AGI. The federal income tax system is progressive, taxing higher income levels at higher rates. Federal income tax rates currently range from 10% to 37%, applied across different income brackets based on filing status.

Individuals typically pay income tax throughout the year through a “pay-as-you-go” system. Employees have income tax withheld from each paycheck, guided by information on Form W-4, the Employee’s Withholding Certificate. Self-employed individuals or those with other significant income not subject to withholding, such as rental income or investment gains, generally make estimated tax payments quarterly using Form 1040-ES. These payments help ensure taxes are paid as income is earned. Income tax revenue primarily funds general government operations, including national defense, public services, and various federal programs.

Payroll Tax Fundamentals

Payroll taxes are deducted directly from employee wages and paid by employers. These taxes fund specific social insurance programs. The primary federal payroll taxes fall under the Federal Insurance Contributions Act (FICA), including Social Security and Medicare taxes. Social Security provides benefits for retirees, disabled individuals, and survivors of deceased workers. Medicare taxes fund hospital insurance for individuals aged 65 and older, and those with certain disabilities.

The Social Security tax rate is 6.2% for both employee and employer. This applies to wages up to an annual limit, which is $176,100 for 2025. The Medicare tax rate is 1.45% for both employees and employers, with no wage base limit. An additional Medicare tax of 0.9% applies to individual wages exceeding $200,000. This additional tax is paid only by the employee, without an employer match.

Employers withhold the employee’s share of FICA taxes from paychecks and remit both employee and employer contributions to the IRS. Other common payroll taxes include the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). FUTA taxes contribute to a federal fund overseeing state unemployment insurance programs. SUTA taxes, which vary by state, fund individual state unemployment benefit programs. FUTA and SUTA are primarily employer-paid taxes and are not deducted from employee wages, though some states require employee contributions for SUTA.

Distinguishing Features and Applications

Income tax and payroll tax differ in purpose and application. Income taxes are broad-based taxes on earnings, funding various government services and operations, from national defense to public infrastructure. Payroll taxes are specifically allocated to social insurance programs like Social Security and Medicare. These funds are legally designated for these programs and generally cannot be used for other government expenses.

The tax base for each varies. Income tax applies to various income sources, including wages, investment income, and business profits. Payroll taxes, specifically FICA, are applied primarily to earned income, up to an annual limit for Social Security, with no limit for Medicare. This distinction means investment income is subject to income tax but not FICA taxes.

Income tax is paid by individuals and corporations based on their overall taxable income. Payroll taxes are a shared responsibility between employees and employers. Self-employed individuals assume both the employee and employer portions of FICA taxes, known as self-employment tax. The self-employment tax rate is 15.3% on net earnings.

The structure and visibility of these taxes on a paycheck differ. Federal income tax withholding varies based on an individual’s Form W-4. FICA taxes are a fixed percentage of wages (up to the Social Security wage base) and are automatically deducted, appearing as “FICA,” “Social Security,” or “Medicare” on a pay stub. Self-employed individuals pay both their estimated income tax and self-employment tax through quarterly payments.