How To Calculate Payroll

To determine federal income tax, you’ll need to have your employee’s W-4 handy and their gross pay calculation. As of 2020, federal income tax withholdings can use either the wage bracket method or the percentage method.

These methods are done using tables on the IRS Publication 15-T form. If an employee’s withholdings haven’t changed since prior to 2020, you can use the previous version of the table.

Wage Bracket Method

Withholdings are determined by W-4 filing status and gross pay. Filing status from an employee’s W-4 form can be:

• Married filing jointly
• Single head of household
• Single or married filing separately

Payroll period options are as follows:

1. Daily
2. Weekly
3. Biweekly
4. Semi-monthly
5. Monthly
6. Quarterly
7. Semiannually
8. Annually

With gross pay calculated in one of these payroll periods, find the box on the corresponding wage bracket method table on the 15-T form that represents the employee’s filing status and gross pay. Note that this method only covers up to approximately $100,000 in annual wages. Employers will need to use the percentage method for employees with gross pay exceeding $100,000.

Percentage Method

Similar to the wage bracket method, the percentage method uses a table with information on gross pay and filing status. However, this method also requires calculating a percentage to add to this flat dollar amount. Consult the IRS 15-T table to find the correct calculations. Figuring out how much to withhold is the bulk of the work, but you’re not out of the woods just yet. You still need to pay the federal and (probably) state income tax you withheld.

Employers must use Form 941 to report withholdings to the IRS every quarter. This includes entering information for employees who received wages, tips, etc., as well as the total federal income tax withheld for the quarter.

If withholdings are $2,500 or more, you’ll have to make an online deposit through the IRS EFTPS system.

While calculating payroll, there are three pay totals that you’ll need to familiarize yourself with to ensure that your calculations are accurate: gross pay, post-tax earnings, and net pay.

• Gross Pay: Gross pay is an employee’s total earnings before payroll taxes and other deductions are made. Contractors and withholding-exempt employees are paid their gross earnings (unless voluntary deductions are made).
• Post-Tax Pay: Post-tax earnings are the wages left after payroll taxes have been deducted. Payroll deductions such as Roth IRA contributions, health insurance premiums, and wage garnishments are subtracted from post-tax earnings, not gross pay.
• Net Pay: Net pay is the amount of wages an employee takes home after payroll taxes and other payroll deductions are made.

Ultimately, business owners are responsible for determining, withholding, and paying any state and local-level payroll taxes owed. State payroll taxes include:

• State income tax
• State unemployment tax
• State benefits contributions
• Local level taxes

Salaried employees have an annual salary usually paid out in two-week increments. For example, if your employee has an annual salary of $40,000 and you pay biweekly, there would be 26 pay periods.

Using the gross salary calculation below, we can see that $40,000 divided by 26 would yield $1,538.46

To calculate gross pay for hourly employees, multiply the employee’s hourly wage by the number of hours worked in the pay period.

For employees earning hourly wages, you’ll need to have their hourly rate handy and the number of hours they worked during the pay period. If your employee has worked 40 hours at $15/hour during the pay period, their gross hourly wages will total $600.

Overtime refers to pay for hours worked beyond a specific weekly threshold (often 40 hours), that requires employees to earn at least time and a half.

Most hourly employees earn overtime pay for hours worked beyond 40, whereas most exempt salaried employees do not qualify for overtime if they make $35,568 or more annually (or $684 per week).

To calculate overtime pay, multiply the hourly rate by the overtime rate and then multiply that by the number of overtime hours worked.

For example, let’s say your employee usually works 40 hours at $15/hour. This week they worked five hours of overtime.

You pay an overtime rate of 1.5 times the normal rate, so their total overtime pay would be calculated like this: ($15/hr x 1.5) x 5 hours = $112.50.

Some workers, especially in the foodservice industry, receive tips from customers. Regulation varies by state and industry, but some portion of tips may be counted toward meeting minimum wage requirements.

There are two ways to calculate tips:

Example: A foodservice worker earning $15/hour over 50 hours, with $350 in tips.

• Using Calculation 1: $10 + $5 = $15/hour
• Using Calculation 2: ($15 x 50 hours) + $100 = $900

Calculating tips for payroll also depends on how a small business allocates tips.

A commission represents a percentage from a sale or transaction that an employee receives as earnings. Commissions may also be offered at a flat-rate.

To calculate percentage-based commission pay, multiply the sale amount by the commission rate.

For example, let’s consider an employee that makes a $1,000 sale and earned a 5% commission.

$1,000 X .05 = $50. In this example, the employee has earned a $50 commission on their $1,000 sale.

Don’t forget that commissions are taxed. The simplest approach for employers is to withhold a flat 22% tax on the employee’s commission. Otherwise, you can consult the instructions on page 20 of the 15-T form.

The federal government uses a progressive tax rate, with high-income earners taxed at higher rates. Under a progressive tax rate, employee earnings are based on the tax bracket the earnings fall under.

For example, under the current federal income tax bracket system, an individual earning $40,000 annually will have the first $11,000 of their income taxed at a 10% rate, and the remaining $29,000 of their income taxed at a 12% tax rate.

All but nine states levy an income tax, in addition to the federal income tax. State income tax rates vary, but are commonly progressive or flat rates.

To calculate progressive income tax, you need to multiply the employee’s gross income by the applicable tax rate.

For example, Massachusetts state income taxes are charged as a flat 5% income tax rate on all residents. We’ll consider an employee with $1,500 in gross wages for the pay period. To calculate state income tax, we’ll use the following formula:

$1,500 X .05 = $75

In this example, the Massachusetts employee would have a $75 state income tax liability.

Local income tax is rare but increasingly common. Many cities charge a flat rate or a progressive income tax.

To calculate the local income tax, you’ll need to multiply the local income tax rate by your employee’s gross earnings.

For example, let’s use a salaried resident of Wilmington, Delaware who is required to pay a flat 1.5% income tax on their $2,500 monthly earnings.

$2,500 X .015 = $37.50 per pay pay period.

So, the employee is responsible for paying $37.50 in income taxes per month.

To calculate social security taxes, multiply the Social Security tax rate by the employee’s gross earnings for the pay period.

For example, let’s calculate Social Security taxes for an employee with $2,000 in gross earnings.

Plugging in the numbers, the equation looks like this: ($2,000) X (.062) = $124.

In this example, the employer owes $124 in Social Security taxes and would pay that out of pocket. The employer would also be responsible for withholding an additional $124 from their employee’s gross income. In total, $248 must be allocated toward Social Security taxes.

As of 2023, the Social Security tax is not deducted on incomes exceeding $160,200. This amount changes annually, so be sure to find up-to-date information.

To calculate Medicare taxes, multiply the 1.45% medicare tax rate by your employee’s gross earnings.

We can calculate the Medicare tax liability for an employee earning $2,000 in gross wages. In this example, we multiply $2,000 by .0145 to get $29 in Medicare taxes owed.

Like Social Security, Medicare follows a fixed rate, and its payment is divided evenly between employers and employees, so your medicare tax liability is the same as your employee’s.

Federal employment insurance contributions (FUTA taxes) are not deducted from employee paychecks but are paid out-of-pocket by employers. However, you’ll still need to make federal employment insurance calculations to make sure you pay the correct amount.

To calculate FUTA taxes, you must multiply your employee’s gross pay by 6% up to the first $7,000 they are paid in the year.

To calculate monthly payroll, determine how many hours your employee worked that month or how much is owed via salary. To the employees’ gross pay — add supplemental pay, subtract payroll deductions, and calculate the employees’s net earnings.

To calculate biweekly payroll, subtract payroll deductions from the employee’s earnings. From there, you will generate the employee’s gross earnings in the biweekly pay period.

Yes, payroll taxes are deductible and should be deducted from your own funds. See IRS Publication 535 for more information on deducting employment taxes.