What is Difference Between Payroll Tax and Income Tax
Payroll tax (mainly National Insurance Contributions) is shared by both employer and employee, while income tax is paid only by the individual based on their total annual income. In fact, a recent HMRC survey reveals nearly 60% of British small business owners struggle to differentiate between these two taxes. This confusion can lead to costly compliance errors, unexpected fines, or missed savings opportunities. In this guide, we’ll walk you through: What payroll and income taxes actually are Who pays what and when 2025 tax rates and thresholds Common mistakes that can cost your business Smart ways to manage both taxes with confidence Let’s break it all down simply and clearly. What exactly is Payroll Tax in the UK? Payroll tax is defined as the National Insurance Contributions (NICs) , a type of tax paid by both employers and employees. It’s deducted automatically from your salary and paid directly to HMRC through the Pay As You Earn (PAYE) system. Unlike income tax, which goes toward funding public services like education and law enforcement, payroll tax funds the UK’s welfare system, including: The NHS State pensions Maternity and paternity benefits Unemployment support Disability allowances If you check your monthly payslip, you’ll usually see “NICs” or “NI” listed as a deduction of your share of the payroll tax handled through our payroll services. Who Pays Payroll Tax? Employees A portion of your gross earnings is deducted automatically and sent to HMRC. Employers They pay an additional percentage on top of your salary as their contribution. Together, these make up the full payroll tax contribution. How Payroll Tax is Collected (PAYE System) Most UK employers use the PAYE (Pay As You Earn) system to handle payroll tax. This allows NICs and income tax to be automatically calculated and deducted before your salary is paid. This means: Employees don’t need to file NIC returns themselves. Employers are legally responsible for accurate deductions and timely payments to HMRC. Employee NICs (Class 1 Contributions) Weekly Earnings (£) Employee Rate £242 – £967 12% Over £967 2% Employer NICs Weekly Earnings (£) Employer Rate Above £175 13.8% Note: Employees earning below £242 per week don’t pay NICs. Employers, however, still may have to contribute depending on thresholds. Types of UK Payroll Taxes 1. Employee National Insurance Contributions (NICs) These deductions show up on your payslip every month, calculated based on your gross earnings. Rates differ based on salary thresholds: Earnings per week (£) Employee NICs Rate (2025) £242 – £967 12% Above £967 2% 2. Employer National Insurance Contributions Employers must also contribute to NICs, calculated as a percentage of employee salaries. Earnings per week (£) Employer NICs Rate (2025) Above £175 13.8% Research by the Institute for Fiscal Studies (IFS) found payroll taxes (NICs) raised around £158 billion in 2024, funding nearly half of the UK’s welfare budget. Understanding Income Tax in the UK: It’s More than Just a Deduction Income tax is paid only by individuals on the total income they earn over a year. This includes money from: Employment (salary or wages) Self-employment Rental income Savings and investments Pensions Unlike NICs, income tax does not fund welfare programs. Instead, it contributes to essential public services such as: Education Law enforcement Transport infrastructure Defence and national security How Income Tax is Collected There are two main ways income tax is collected in the UK: PAYE (Pay As You Earn) If you’re an employee, your employer deducts your income tax each month before paying you, based on your tax code. Self-Assessment If you’re self-employed or have other income (like rental income or dividends), you must file a Self Assessment tax return each year and pay directly to HMRC. UK Income Tax Rates (2025) Income tax rates vary based on annual earnings: Income Bracket (£) Income Tax Rate Up to £12,570 0% (Personal Allowance) £12,571 to £50,270 20% (Basic Rate) £50,271 to £150,000 40% (Higher Rate) Above £150,000 45% (Additional Rate) Who Needs to Pay Income Tax? You must pay income tax if: You’re a UK resident earning over £12,570 per year You’re self-employed, a landlord, or a shareholder earning dividends You earn additional income from freelance work or side businesses Even if you’re on PAYE, you may still need to file a Self Assessment return if you: Earn over £100,000 Have untaxed income Claim certain tax reliefs (like business expenses) Did You Know ! Over 95% of income tax returns are now filed online and the UK’s “Making Tax Digital” initiative is expanding to include even more self-employed individuals in the coming year. 7 Key Differences Payroll Tax vs. Income Tax Understanding these key differences clearly can help you handle tax obligations smoothly, avoiding costly errors: Aspect Payroll Tax (NICs) Income Tax Purpose & Allocation Funds welfare (e.g., NHS, pensions, benefits) Funds public services, infrastructure, defence Taxpayer Responsibilities Shared by employer and employee Primarily individual; employers deduct only Calculation Method Flat-rate percentage (weekly/monthly earnings) Progressive rate (increases with earnings) Tax-Free Allowance Lower threshold (£242 per week) Higher personal allowance (£12,570 per year) Impact on Employers Employers bear significant cost Employers deduct but don’t personally pay Reporting & Filing Monthly/Quarterly (via PAYE) Annual self-assessment or PAYE deducted Consequences of Non-Compliance Higher penalties, frequent audits Penalties significant but negotiable with HMRC Income Tax Differences by Country While payroll taxes focus on social security and national benefits, income tax directly affects employees’ take-home pay. Most countries follow a progressive income tax model, meaning the more you earn, the more tax you pay but the rules, brackets, and responsibilities differ widely. Here’s how income tax is handled in four key countries: United States: The U.S. income tax system operates at both federal and state levels. In 2024, federal tax rates range from 10% to 37%, depending on your income bracket. For example: Income between $11,001 and $44,725 is taxed at 12% Income between $44,726 and $95,375 is taxed at 22% On top of this, most states impose their own income taxes except for a few like Texas, Florida,
