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Table of Contents
For starters a payroll, you have to calculate the withholdings and provide them to the relevant parties, which means that you are entering the tax territory. Managing your payroll with an in-depth understanding of income and payroll taxes becomes easy. It is expected that some of the tricky tax terms will need to be understood. Therefore, we have prepared a guide for you to understand these terms and ultimately find the difference between payroll tax and income tax, their calculations, and the best ways to be tax compliant.
Understanding Payroll Tax
Payroll taxes comprise income tax and tax designated for social security, medical care, and unemployment welfare. One important thing to understand is that both the employer and employee have to pay these taxes.
Key Features of Payroll Taxes
Here are some important terms related to payroll taxes:
Federal Income Tax withholding
Businesses must subtract the federal income tax from the employee wages. This amount is based on the worker’s annual income and the number of allowances on their Form W-4. Withholding amounts are given to taxing authorities, and this amount is not an expense for the employer.
Social Security Tax
The current amounts of social security taxes are as follows:
- 2% for the employer
- 2% for the employee
This amount, summed up, equals 12.4%. For this past year, up to $160,200 of taxable wages are dependent on social security tax.
Medical Care Tax
The present rate of medical care tax is 1.45% for the employer and 1.45% for the employee, which equals 2.9% in total.
Unemployment Taxes
Many employers typically pay both federal and state unemployment taxes. The net federal and state unemployment taxes paid are based on each state’s unemployment status. The federal unemployment tax rate is 6% on the initial $ 7,000 paid to each employee in gross salaries annually. At the state level, the salary dependent on unemployment tax might differ depending on the state’s regulations.
State and local income taxes
Many states in the US might also be required to withhold state and local income taxes from their employee’s wages. Currently, only a handful of states do not charge an income tax.
For the workers who lost their jobs, the Federal Insurance Contributions Act (FICA), Fund Medicare and Social Security, the Federal Unemployment Tax Act(FUTA), and the State Unemployment Tax Act(SUTA) were passed.
Understanding Income Tax
Income tax is a category of tax that the federal government imposes on individuals, businesses, and other entities based on their annual income and profits. Individuals have identified taxes on many types of incomes that are not just about their salary, like interest rates, rents, dividends, gambling winnings, lottery winnings, rents, unemployment benefits, self-employment finances, etc.
As of 2024, eight states in the United States do not charge income tax. These include Alaska, Nevada, Florida, Texas, South Dakota, Tennessee, Washington, and Wyoming.
Here are some of the critical components of Income Tax:
Tax Rates
Income tax generally consists of progressive rates; therefore, the higher the income levels, the higher the income tax rates will be. Furthermore, these tax rates can also vary from state to state.
Credits and Deductions
Regular taxpayers can be eligible for deductions and credits that can reduce their taxable income. Some instances include charitable contributions and certain business expenses.
Taxable incomes
This is a portion of a worker’s salary that is subject to taxation. It includes wages, salaries, and business gains.
Withholding
Employers are entitled to keep a portion of employees’ wages for income tax purposes. Self-employed individuals and firms must make quarterly calculated tax payments.
Payroll operations require the business to withhold income taxes on employee wages after this, the wages are presented to the appropriate taxing authority for further processing, which can be federal, the local department of revenue, or state-based.
Key contrasts between Payroll tax and income tax
These are two distinct types of taxes that have different motives and uses. Following are some of the essential differences between payroll taxes and income taxes:
Tax rates
The present federal payroll tax rate is 15.3%, which includes both the employer and employee offerings. The federal income tax rate varies from 10% to 37%.
Application
The payroll tax applies to employees’ wages and salaries. Income Tax applies to various income sources, including wages, salaries, and business financial gains.
Usage
Payroll taxes are applicable on the following three programs:
- Social Security
- Medicare
- Unemployment Benefits
Income taxes are more common on public services and expenditures.
How to calculate payroll tax
Payroll tax is deducted from the worker’s annual income and allowances, as depicted on the Form W-4. Employers then send the withholding rates to every taxing authority.
If the total income of an employee is $25000, here is a simple formula to calculate it:
- Employee tax (FICA): $25000 * 15.3% = $3825
Here:
7.65% paid by both the employer and employee = 15.3%
How to calculate income tax
To calculate income tax, the employee’s gross income, including wages, salaries, and other sources of income, must be determined.
Gross wages can be calculated using the annual salary or understood by determining the hourly rate of pay and hours worked. The gross wages received are the largest payroll cost and include payments to employees and independent vendors.
Now, you need to determine if they are eligible for any adjustments to income, such as enhancements to retirement accounts, benefits, deductions, and HSA contributions. Now, subtract these total enhancements from the gross income to determine how much income is taxable.
To find out the exact amount of income tax to withhold, you can check the IRS withholding tables or go hassle-free with an accounting software that provides these calculations.
