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You would be surprised at the number of people who use the terms income tax and payroll taxes in place of each other. However, they are quite different and need to be approached with a fine-tooth comb. To address the question Payroll Tax vs Income Tax- What Are The Differences, we will break down the concepts for you and help you grasp each of these terminologies in a better way.
The world of tax is a tricky field for many to navigate. We are often confused by the concepts related to tax and end up misunderstanding many terminologies. Though not at all difficult, many ends up fearing the topic and do not bother to try and understand what these concepts mean and what are the differences in such concepts.
Often these concepts sound very similar and make it difficult for us to get a hang of them. We tend to run away and let our chartered accountants handle the unpleasant task of sorting through our paperwork and figuring out our income tax liabilities.
For a business, tax often means countless hours of poring through bundles of documents and checking through seemingly complex concepts. One such question that rears its head is Payroll Tax vs Income Tax- What Are The Differences?
Now we understand the affinity for people to stay away from such complex concepts. However, we are here to help you make sense of these “complex” terminologies and will help you figure out what each of them means. Stay with us and learn the basics of these tax terminologies and get your answer to the question Payroll Tax vs Income Tax- What Are The Differences?
Before we dive further into the details of payroll tax vs income tax, we will need to understand what each of these words entails. We will first wade through the concept of Income Tax, understand why there is a tax on our income, and get to the bottom of what happens after we pay our income tax. Concepts such as income tax expense and income tax liabilities will be explained so that you get a holistic view of the topic.
We will also try and understand who collects the income tax and for what purpose does the money thus collected gets used up. Then we will move on to the concept of the Payroll Tax. Topics like who is liable to pay the payroll tax, what does payroll tax deferral, and payroll tax expense mean will also be dealt with. And finally, once we get our head around the concepts of Income Tax and Payroll tax, we will tackle the all-important ‘Payroll Tax vs Income Tax- What Are The Differences?’ question.
Before you move into understanding both terminologies, know that these calculations are based on the GAAP which are the Generally Accepted Accounting Principles and the International Financial Reporting Standards (IFRS). Both of these systems provide essential guidelines for the treatment of various items of both incomes as well as expenses, keeping the acceptable government codes of tax in mind.
What Is Income Tax?
The most popular definition of income tax is “it is a type of tax levied by the government on both individuals and businesses operating in their jurisdiction based on the incomes generated by them.”
This means the tax which the government collects, probably through a regional income tax agency, is a source of income for the government. Individuals and businesses operating in a particular region, state, or country are liable by law to provide a certain share of their earnings to the government.
Income can have multiple meanings. It doesn’t mean only the salaries earned by an individual. The government collects a direct tax from both individuals and businesses based on the various incomes they receive from house property, gains from the profession that they indulge in along income received from other sources, which means even capital gains income.
For businesses, the tax is often levied on the profits they accumulate as part of running the business.
For What Purpose Is The Income Tax Collected?
You may want to know the reason why the government collects income tax from individuals and businesses. The tax which is collected by the government is their basic source for funding numerous public services, provide for the various obligations that each government might have to fulfill, and at the same time, ensure the public is provided with goods and essential services.
Now based on who it is collected from, Income tax can be both Personal Income Tax or Business Income Tax. As the name suggests, when the government taxes the individual on the basis of the salary he earns or for the other type of earnings he might have, it is called personal income tax.
When business houses and corporations are taxed on their income, then it is called business income tax. The entities that are taxed include small businesses, partnership firms, sole traders, or even self-employed individuals.
What Is Income Tax Expense?
Having understood the basics of income tax and the purpose for which income tax is levied, let’s now take one small step towards figuring out Payroll Tax vs Income Tax- What Are The Differences?
For that, first, we need to understand what Income Tax Expense is. Simply put, any expense that an individual or business organization has to pay on the income earned by them in each financial year as per the income tax norms is called Income Tax Expense. The businesses recognize a certain amount of money each financial year as a corpus that needs to be given to the government.
Since this money is flowing out, it often features in the income statements of business firms under the category “other expenses”. Tax expense is calculated using the formula Taxable Income * Tax Rate.
Usually, the calculation of income tax expenses can be extremely complex. Hence business firms prefer providing the calculation work to experts that handle end-to-end tax calculations and offer their services for a fee.
What Is Income Tax Liability?
Tax liability can be best explained as the amount of money that makes up the tax debt that you owe to the tax authorities of your country.
Also, note that Income Tax Liability doesn’t just mean the amount of money owed by you in the current financial year. It is the sum total of the amount of money that you are due to pay to the government or a regional income tax agency factored in for all the years you are liable to pay taxes.
These income tax liabilities are very much binding on individuals as well as business organizations. If you fail to pay off your tax-related debt, then it results in you having to pay back taxes or a tax lien. It might also attract penalties or interests. Sometimes, you might even be punished for non-payment of these dues. Punishments can even include a jail term.
That completes one-half of understanding a complex tax concept. We are now close to answering the question Payroll Tax vs Income Tax- What Are The Differences?
Now let’s see the other side of the ‘Payroll Tax vs Income Tax- What Are The Differences?’ debate.
What Is A Payroll Tax?
This is a tax especially catering to the business organization. These are the taxes imposed on employers and the employees based on the salary or wages paid to the employee by the employer.
The Payroll Tax is collected by the government through their regional income tax agency in two ways.
Herein lies one of the biggest differentiators for the question regarding Payroll Tax vs Income Tax- What Are The Differences?
The Payroll Tax has to be paid by both the employer and employee.
How is the Payroll Tax collected?
- The payroll tax can be collected directly from the employer’s own fund relating to the employment of an individual employee.
- The payroll tax is paid to the government by the employer by withholding a certain sum of money from the employee’s salary or wages.
Another question that might arise in your mind while wondering about ‘Payroll Tax vs Income Tax- What Are The Differences?’ What is the purpose of collecting payroll tax?
The payroll tax pays for funding the social security system in a country or the Medicare facilities or even certain insurance programs. It, therefore, consists of the unemployment taxes and also pays back the employee during his retirement years as monthly payments.
An interesting thing that happened during the times of the pandemic was the payroll tax deferral that was allowed by the government.
You will ask, what is a payroll tax deferral? Look at it as a leeway offered by the government to business houses to delay the payment of the payroll tax to the government.
This relaxation given by governments across the world has helped business firms survive during the pandemic.
What Is Payroll Tax Expense?
Another concept that often confuses is the concept of payroll tax expense. Understand it as the cost that the business firm has to incur to hire employees. The organization then needs to withhold certain amounts from the gross salary of these employees which then goes into the payment of Payroll Taxes.
There you go! In our pursuit to answer ‘Payroll Tax vs Income Tax- What Are The Differences?’, we have taken you through an understanding of what income tax is. What are the types and components of the income tax? We have then discussed where the money collected as income tax goes and gets used for what purposes. We also detailed out how payroll taxes are different from incomes taxes and what are the circumstances of levying payroll taxes. We also touched upon the recently allowed payroll tax deferral by the government and explained what payroll tax expense is.
If we were to give you a summary on Payroll Tax vs Income Tax- What Are The Differences? we would be able to differentiate both sets of taxes as follows:
- On the basis of who are the contributors, Income Tax is contributed by the employee, whereas for Payroll Tax both employer and employee have to contribute
- On the basis of elements of tax, you can say that the Income Tax consists of Federal tax, State tax, and certain local taxes. The Payroll Tax, on the other hand, consists of Medicare tax, social security tax, and unemployment tax.
- On the basis of source, Income tax is based on income received from numerous sources considered across one entire financial year. Payroll tax only considers the income from wages or salaries that the employer pays the employee.
- On the basis of the nature of the tax, while Income Tax is often progressive in nature, the Payroll tax is usually regressive.
- On the basis of the purpose for which it is collected, Income Tax contributes to the purpose of social welfare and for governmental workings. Payroll tax contributes to the safe and secure future of the employees and their various benefits.
So finally, we learn that both taxes are important contributors to a healthy society. While income tax helps sustain the government working, payroll tax helps keep the future of the employee secure. Both taxes involve a lot of tedious calculations and therefore need a careful study before we calculate them. While discussing Payroll Tax vs Income Tax- What Are The Differences? we have now summarized what each tax concept involves and what are the implications of paying both taxes for all parties involved.
We hope you are now clear about the whole Payroll Tax vs Income Tax- What Are The Differences? argument and we have managed in our own small way to contribute to your knowledge. One last suggestion that we have for you is always to be on top of the tax calculations by having good payroll software that will help with the calculations and take the help of experts who will be able to guide you in these core concepts.