Income Tax vs. Payroll Tax: Key Differences & Calculation Tips

Running a business in today’s dynamic landscape involves several challenges. One of the most significant ones is keeping updated with the types of taxation: income tax and payroll tax. Which one applies to you and your employees? How are they calculated? How do they differ from each other? Not only is this knowledge critical to keep your business on the right side of the government, but it also ensures you don’t lose money toward penalties and other legal charges.

In this article, we discuss the vital differences between income tax and payroll tax. We’ll also discuss how to build a W-2 form and a paystub online to streamline the process of calculating and filing taxes.

Payroll Tax

This tax deducts a certain percentage of an employee’s income toward social security and Medicare schemes. Together, these two contributions comprise the Federal Insurance Contributions Act (FICA) tax. Unemployment taxes get paid as a part of payroll tax; this comes under the Federal Unemployment Tax Act (FUTA).

Notably, your social security contribution gets deducted when you reach a set income threshold. It gets affected by the rate of inflation. However, the Medicare component of the payroll tax depends on your salary.

Income Tax

This tax is a payment made by an individual based on their total income. It includes earnings through salary, bank interest, sale of property, etc.

The amount of income tax you will have to pay depends, understandably, on your income. It also varies across different states in the US. To figure this out, you need to fill a W-2 form for the Internal Revenue Service. It reports the annual wages of an employee with the breakdown of taxes withheld during the year. It is a good idea to use a free check stub maker with calculator. A W-2 form generator can speed up the task while maintaining accuracy.

Calculating Payroll Tax

It is a regressive tax. It implies that the amount of tax reduces as your income increases. The required amount needs to be paid by both the employer and the employee. While FUTA tax is paid wholly by the employer, both parties need to pay FICA taxes.

Generating and maintaining paystubs for every pay period is an essential step to keep updated with your taxes. You can use an online paystub generator to simplify this task and reduce the involved expense. For instance, at StubCheck.com, you can quickly create paystubs at only $3.99 apiece, receiving the first one free of charge. Once you have your paystubs, it becomes simple to calculate the payroll tax in a few quick steps:

• Find your gross wage: How many times are you getting paid in a year? For instance, if an employee earns $15000 every month, his yearly income is $180000. Additionally, if he also gets medical insurance of $200, his monthly wages become $15200. Likewise, here you will need to include any others additions such as bonuses or vacation pay.

• Figure out the exemptions: Which deductions are you eligible for? It is best to discuss this with your employer or a tax accountant.

• Calculate the tax at the fixed rate: Find out the rate applicable during the fiscal year. For example, as of 2021, the payroll tax rate for social security is 12.4% (6.2% each for the employer and the employee). For Medicare, the present rate is 2.9% (1.45% each).

Calculating Income Tax

It depends on the bracket in which your pay fits. Typically, the more you earn, the greater is the tax. For 2021, the applicable tax brackets are 10%, 12%, 22%, 24%, 32% 35%, and 37%. The income that fits into each bracket depends on whether you are an unmarried individual, part of a couple filing joint returns, married and filing your return separately, or the head of your household. Note that you will have to pay this tax whether you are an employee or a self-employed individual.

• If you are employed by an organization: You will fill up the Form W-4. It has details like your total earning, deductions/exemptions, the number of dependents, and your marital status. These will get processed by the payroll software to arrive at your income tax.

• If you are self-employed: The income tax you pay depends on the legal structure of the business. It could be a partnership, a limited liability company (LLC), a solo enterprise, etc. To calculate your tax, estimate your yearly income by basing it on your quarterly earnings. Similarly, you can calculate your annual expenses while factoring in any variations depending on the quarter. Now, you can arrive at your taxable income. Remember to use any tax credits for which you might be eligible. You will pay income tax on this taxable income based on the tax rate.

It is considered a good idea to calculate the tax in each quarter to minimize the risk of making a huge payment at the end of the fiscal year. Understanding the differences between payroll- and income taxes is imperative for individuals and business owners alike to keep on top of their finances.