As an employer, it’s important to understand the difference between types of taxes and which categories are essential for your team members to comprehend. There are many different types of taxes, but this article focuses on payroll and personal income taxes. Here’s what you need to know about payroll taxes and how they differ from personal income taxes.
Payroll vs. Income Tax
Payroll taxes are taken from an employee’s pay by their employer, where that sum is paid to the government in the employee’s name; this is a pretty straightforward/standard tax that all businesses must pay, including small businesses, even with just a single employee.
Meanwhile, income taxes are taxes levied upon businesses and citizens based on their earned income. Each year, everyone who has earned income must complete an income tax return to properly ascertain how much they owe in state and federal taxes.
Employees and Employers
The payroll tax rate for employees and employers is a combined 15.3%. In theory, this amount is supposed to be divided equally between employers and employees, with each side paying 7.65%. However, some companies lower wages by that same amount and effectively shift costs onto employees.
According to the National Bureau of Economic Research (NBER), higher income tax rates can lead to people working less; this typically happens because employees see their take-home pay decline as the income tax rate increases. One study found that raising the tax rate by 12.8% leads to “122 fewer hours of market work per adult per year, and a 4.9 percentage point drop in the employment-to-population ratio.”
Some would suggest that when the government increases corporate income tax rates, the employees suffer. Another NBER study found that corporate tax rates, wages, and employment have an inverse relationship. Data suggests that as corporate income tax rates increase, wages and employment decrease, which is not usually the intention of those lobbying for higher corporate income taxes.
State and Federal Governments
The question remains: where do payroll and income taxes go? We’ve already covered the federal payroll tax rate, which is 15.3%. The federal government calculates this by collecting 12.4% for Social Security and 2.9% for Medicare, which adds up to 15.3%.
Federal income taxes go to various government programs and Social Security and Medicare. These include but are not limited to income security programs, veteran’s services, defense, education, housing, and urban development.
State income taxes are allotted similarly, with one exception. On average, 41% of a state’s budget goes to K-12 and higher education. An average of 17% of state income taxes fund Medicaid and children’s health insurance programs. Other areas funded by state income taxes include salaries and benefits for public employees, state parks, economic development, and environmental projects.
We hope this piece has helped clarify some of the basic tax questions you may have as a small business owner.