What Is a Difference Between Payroll and Income Taxes?
As a small business owner, you're facing MANY tax obligations, which can quickly get overwhelming. Two major types of taxes that you'll encounter are payroll taxes and income taxes.
Both involve payments to government agencies, but they serve different purposes, follow different rules, and create different responsibilities for your business.
So, what is a difference between payroll and income taxes? Here's a simple guide for small business owners so you can meet deadlines and avoid IRS penalties.
What Is Income Tax?
Income tax is the government's cut of the profits your business earns. The income tax system is progressive, which means that higher income levels get taxed at higher percentages.
As a small business owner, you're required to pay tax on your business income after deducting legitimate business expenses. This applies whether you operate as a sole proprietor reporting business income on your personal return, or as an LLC or a corporation filing separate business returns.
Your business structure determines exactly how and when you pay these taxes, quarterly estimated payments for most small businesses, or annual returns with potential refunds or additional payments due.
What Are Payroll Taxes?
Payroll taxes are what you collect and pay whenever you have employees.
These taxes fund specific government programs. As an employer, you're responsible for withholding portions of your employees' wages and contributing additional amounts from your business funds.
The major payroll taxes include Social Security and Medicare (together known as FICA taxes), federal and state unemployment insurance, and workers' compensation insurance. Payroll tax rates are generally fixed percentages with wage caps for some components.
Learn more about small business taxes.
What Is a Difference Between Payroll and Income Taxes?
Payroll taxes come out of employee paychecks and fund specific programs like Social Security and Medicare. Your business must collect these from employees and contribute a matching portion.
Income taxes are paid on your business profits after expenses. You pay these based on how much your business earns, not a fixed percentage.
In other words, income tax is on what your business makes, and payroll taxes are on what your employees earn.
How Much Do You Have to Pay in Income Taxes?
Income tax rates for small businesses depend on your business structure.
For sole proprietors, partnerships, and S corporations, profits pass through to your personal tax return and follow federal tax brackets ranging from 10% to 37% (2025 rates). C corporations pay a flat 21% federal corporate tax rate.
Most small businesses also face state income taxes ranging from 0% to about 12% depending on your location. You can often reduce your effective tax rate with tax deductions and credits.
Income Tax Example
Let's say you run a graphic design business as a sole proprietor that earned $80,000 in revenue last year. After deducting $30,000 in legitimate business expenses (software, office rent, equipment), your taxable business profit is $50,000.
This $50,000 flows to your personal tax return as business income. Assuming you're single with no other income and taking the standard deduction ($15,000 for 2025), your taxable income becomes $35,000. For 2025, this puts you in the 12% and 22% brackets.
You'd pay 10% on income up to $11,925, then 12% on income between $11,925 and $48,475, resulting in approximately $4,066 in federal income tax. You'd also pay any applicable state income tax.
How Much Do You Have to Pay in Payroll Taxes?
For employees, you must withhold and pay:
6.2% Social Security tax
1.45% Medicare tax
As the employer, you match the 6.2% Social Security and 1.45% Medicare. You also pay:
Federal unemployment tax (FUTA): 6% on the first $7,000 of wages
State unemployment tax: varies by state
Self-employment taxes apply when you're both employer and employee. For example, when you're an employee of your S-Corp. In this case, you pay both halves of Social Security and Medicare taxes for a total of 15.3% on net earnings (12.4% for Social Security and 2.9% for Medicare).
Payroll Taxes Example
If you have an employee earning $60,000 annually ($5,000 monthly), each month you should withhold:
$310 for Social Security (6.2% of $5,000)
$72.50 for Medicare (1.45% of $5,000)
As the employer, you'd also pay:
$310 matching Social Security tax
$72.50 matching Medicare tax
FUTA tax of 6% on the first $7,000 of wages, which amounts to $420 total for the year (or about $35 per month in the first 7 months)
State unemployment tax (varies by state)
Total monthly payroll tax cost for the first 7 months: approximately $800 ($382.50 withheld from employee plus $417.50 employer portion including FUTA).
If you're self-employed earning $60,000 in net profit, you'd pay about $9,180 annually (15.3% of $60,000) in self-employment tax. Half of this amount ($4,590) would be deductible on your personal income tax return.
With the 2025 standard deduction of $15,000 for single filers, your taxable income would be $40,410, resulting in about $4,876 in income tax plus the $9,180 in self-employment tax.
Why It's Important to Understand the Difference Between Payroll and Income Taxes
It's very important to understand the difference between payroll and income taxes to pay the right amounts on time and stay compliant with the IRS. Mixing them up can lead to incorrect tax payments and penalties from tax authorities.
At Desi Tax Service®, we help small business owners find clarity in tax season and start saving money you didn't know you had. Learn more about our tax services!
