A Primer to Payroll Taxes

January 9, 2020
A Primer to Payroll Taxes


Payroll Taxes are taxes that are deducted from an employee’s salary by an employer. Payroll taxes are usually a small percentage that is deducted from an employee’s salary. These taxes are used for various purposes and to cover programs such as medical insurance and social security for employees. This is done when employers deduct those amounts and send them to appropriate government agencies. This is how employees look out for their employee’s interests.

The Basic Categories of Payroll Tax

Payroll taxes are distinct from income taxes in that they are used to fund specific programs and initiatives. Payroll tax broadly falls into two categories:

  • Withholding Tax: This category refers to a certain percentage that an employer is obligated to withhold from their employees. This amount is paid to the government, who are responsible for the levying and collection of taxes as per the various slabs delineated in the Income Tax Act. It is also called a retention tax. Withholding taxes are used for the generation of revenue for the government and, eventually, the funding of various programs such as disability and employment. 
  • Tax Paid in Lieu of Employee Wages by Employer: An employee from their salaries directly pays these taxes. These taxes are responsible for an employer to cover an employee’s participation in social security and insurance programs.

Payroll taxation errors can lead to heavy penalties and noncompliance. In many cases, effective payroll management systems or third-party vendors like payroll service providers can handle these aspects without burdening management.

Taxation in India

In India, payroll is taxed based on salary slabs. There are 4 major salary slabs in India. As of 2019-2020 they are:

  • Up to rupees 2,50,000 – No tax
  • Between rupees 2,50,000 – rupees 5,00,000 – 5% of taxable income 
  • Between rupees 5,00,000 – rupees 10,00,000 – Rupees 12,500 and 20% of income
  • Above 10,00,000 – Rupees 1,12,000 and 30% of income. 

The government collects taxes by TDS (Tax Deducted at the Source), TCS (Taxes Collected at the Source), and voluntary payment by taxpayers to designated bank branches. TDS is clearly delineated in Section 196 of the Income Tax Act, 1995.

Payroll Compliance

The following laws and acts primarily govern taxation in India: 

  • Minimum Wages Act, 1948 – The Minimum Wages Act 1948 is an act concerning labour and wages where the act delineates the minimum wages that are to be paid to skilled as well as unskilled workers as well. Each state has a specific minimum wage of their workforce. 
  • (ESI Act) Employee’s State Insurance Act, 1948 – The ESI Act of 1948 saw the establishment of the Employee’s State Insurance corporation that is responsible for funding social security and health insurance schemes for employees. 
  • EPFO (Employee Provident Fund Organization), 1952 – The Employee Provident Fund is an initiative taken to safeguard the interests of an employee. Both employee and employer deposit a certain percentage of the employee’s salary, the whole of which will be given to the employee at the time of retirement. 
  • Payment of the Gratuity Act, 1972 – This act was passed to help employees, financially, at the time of their retirement. This enables employees to claim a certain amount of money as a retirement benefit. 

Payroll can be a very tricky process, and calculation of TDS and TCS is a very common oversight that most managers and employers have fallen prey to. However, payroll management systems such as Gusto, OnPay, and Xero have changed the game, making it easier for managers to deal with the workload. Payroll Management Systems have also shifted to cloud-based storage that also makes for great data security and accessibility and eventually reducing payroll errors.


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