What are payroll taxes?

Calculating how much is owed in tax is a crucial part of the payroll process. The payroll department has to determine how much income tax to deduct from employee salaries and wages to work out the final net amount on each employee’s paycheck. 

But in addition to income tax, there are other taxes levied on employees and employers. These additional levies are commonly referred to as ‘payroll taxes’. But what exactly is payroll tax? How is it different from income tax? And what charges and contributions fall into the payroll tax category?

The first thing to remember about payroll tax is that there is no standardized definition that is valid on an international level. Depending on which publication you consult or where in the world you are, a different definition may apply. In the United States, for instance, payroll taxes specifically refer to federal social security and medicare levies, hence taking on the form of a social security tax. 

In many countries, however, the term ‘payroll taxes’ is used more loosely to refer to all types of taxes employers incur by employing and paying employees, hence including everything from social security contributions to unemployment insurance, sometimes even including employee income tax. Some countries have their own specific definition of payroll tax. One example is Australia where payroll tax is a specific tax levied on employers by the different states and territories. 

The Organization for Economic Cooperation and Development has yet a different understanding of payroll taxes. According to the OECD, “[t]ax on payroll is defined as taxes paid by employers, employees or the self-employed, either as a proportion of payroll or as a fixed amount per person, and that do not confer entitlement to social benefits.” Some examples for payroll tax following this interpretation would be France’s social debt repayment contribution (CRDS).

In the broadest sense, payroll taxes can be defined as taxes which are levied on wages and salaries and which are paid by either the employee or the employer, or both.

In the U.S. as well as in many other countries, payroll tax and income tax are treated as two different concepts which differ with regard to two critical factors: one being by whom the tax is paid, and the other being what the collected tax money is used for. 

Income tax on employment income is exclusively paid by the employee, while payroll taxes are paid by the employee as well as the employer—or, in cases like Australia, solely by the employer. Payroll taxes are used to fund specific social security programs (or other government-led schemes destined to improve the social welfare of employees). Money collected from federal, state and local income tax, on the other hand, is used for public services, infrastructure, and government spending in general.

Another difference between income tax and payroll tax that holds true for many countries are the tax rates. In many countries, payroll tax is levied at a fixed rate that applies to all employees and employers (except maybe for low-income earners who are often exempt), while income tax rates are usually progressive.

Having said that, there also are cases where income tax is considered a part of the overall payroll tax burden.

As we’ve seen, the use of the term ‘payroll tax’ differs from one country to the next, as do the specific payroll taxes which are levied on employees and employers. On the most general level, payroll tax can include any tax that is levied on an employee’s wages or salaries—which, in this sense, would make them the equivalent of statutory payroll deductions. Here’s a list of contributions and tax levies that can figure under the payroll tax umbrella:

• Federal, state and local income tax

• Unemployment tax

• Health insurance contributions

• Long-term care insurance contributions

• Pension fund contributions

• Workers’ compensation insurance levies

• Disability insurance levies

• Education levies

• Church tax

• Solidarity tax

• Self-employment taxes

Payroll taxes are levied on income earned from employment, which means that employers have certain responsibilities towards making sure the adequate amount of tax is deducted from each employee’s pay and then remitted to the authorities in a timely manner. Except for a handful of countries, employers have to handle the following tasks when it comes to payroll taxes: 

• Calculating the employee share of the payroll taxes

• Deducting the employee-paid payroll taxes from his or her salary/wages

• Calculating and paying the employer share of the payroll tax levy

• Remitting the amounts due to the authorities in charge

• Reporting payroll taxes by submitting the necessary payroll tax declarations

So, to answer the question of who pays payroll tax: It’s the employer who pays payroll taxes on behalf of the employee. Usually, however, at least a part of this amount is deducted from the employee’s gross earnings.