The Complete Guide On How To Calculate Payroll & Payroll Taxes

Payroll tax calculations can be challenging for even the most seasoned small business owner. Managing payroll in-house means understanding how to calculate payroll taxes at the federal, state, and local levels — it can get overwhelming.

If you need help making payroll tax calculations, we’ve got you covered from FICA to FUTA and everything in between.

This guide breaks down everything you need to know about payroll calculations, from calculating payroll taxes to handling wage deductions. Let’s dive in.

What Are Payroll Taxes?

Payroll taxes are employer and employee tax liabilities on wages, salaries, and other earnings. Employers are responsible for reporting and withholding payroll taxes liabilities from employee earnings and paying the employer’s share of payroll taxes.

There are federal, state, and local-level payroll taxes, including FUTA, FICA, state unemployment insurance taxes, and income taxes. Governments collect payroll taxes to fund various insurance programs and other public ventures.

A Quick Summary Of Payroll Taxes

When calculating payroll taxes, there are many payroll taxes to consider. Here’s a list of the most common payroll taxes:

• Social Security (FICA)
• Medicare (FICA)
• Federal unemployment insurance tax (FUTA)
• State unemployment tax (SUI)
• Federal income tax
• State income tax
• Local income taxes

For a more in-depth look at small business payroll taxes, check out our complete guide to payroll taxes for small businesses.

Is There A Formula For Calculating Payroll Taxes?

While you can use a single formula to calculate payroll taxes, it’s inefficient, time-consuming, and challenging to do so. However, if you’re determined to learn how to calculate payroll taxes manually, you can use the following formula:

If you choose to use a single formula to calculate individual payroll taxes (FICA, FUTA, income tax, etc.), you can total the sums to get your full payroll tax liability.

However, there are a few caveats to using a formula to calculate payroll taxes.

• Each payroll tax rate percentage should be converted to a decimal. To do so, divide the rate by 100.
• You must calculate each payroll tax individually, as you can’t just add all the payroll tax rates together and plug that number in — you’ll get the wrong answer.

In short, it’s not advisable or particularly efficient to calculate payroll taxes manually using a single formula.

How To Calculate Federal Payroll Taxes

To learn how to calculate federal payroll taxes, you’ll first need to know the federal payroll tax rates. Here’s a breakdown of federal payroll taxes and their rates:

• Social Security Tax: The combined Social Security tax rate is 12.4%, with employers responsible for paying 6.2% out of pocket and withholding the employee’s 6.2% share. Social Security taxes total 12.4% and may be levied up to the $147,000 taxable wage limit.
• Medicare Tax: The combined Medicare tax is 2.9%, with employers responsible for paying 1.45% out of pocket and withholding the employee’s 1.45% share. Medicare tax increases by 0.9% for individuals earning over $200,000 annually.
• Federal Unemployment Insurance Tax: The current FUTA tax rate is 6% on the first $7,000 in wages paid to an employee per tax year.
• Federal Income Tax: The federal government uses a progressive tax rate, with higher income earners taxed at higher rates. Employers are responsible for withholding federal income taxes in accordance with the employee’s W-4 form.

For example, let’s calculate Social Security taxes for an employee whose gross earnings total $2,000 per pay period using the payroll tax calculation formula:

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.

How To Calculate State Payroll Taxes

Once you’ve gotten federal payroll tax calculations down, you can move on to learning how to calculate state payroll taxes. Unfortunately, state payroll taxes are highly variable and can include local-level taxes that are dependent on the location in which your business operates. Here’s a look at the most common state payroll taxes you need to know:

• State Unemployment Tax (SUI): State unemployment tax rates vary by state.
• State Income Tax: State income tax rates vary by state, with nine states that don’t levy a state income tax.
• Local Taxes: Local tax rates vary by location.

Regardless of your state’s payroll taxes, you can use the following equation to determine your state-level payroll tax liability:

For example, let’s consider the state of Colorado, which levies a flat 4.55% income tax at the state level. In this scenario, let’s say your business operates in Colorado and pays an employee $2,000 per pay period. Plugging in the numbers, the equation to calculate state income tax would look like this: ($2,000) X (.0455) = $91.

In this example, your business would be responsible for withholding $91 in state income tax from this employee’s paycheck.

Ultimately, you’ll need to do some sleuthing to determine your state’s payroll taxes. Fortunately, we’ve made it easy for you.

How To Calculate Payroll in 8 Steps & Pay Your Employees Correctly

Figuring out how to calculate payroll and payroll taxes is a valuable skill for any business owner, as employers are responsible for calculating, withholding, and paying payroll taxes in addition to running payroll. The following step-by-step instructions will take you through the process of calculating payroll and managing payroll taxes for your small business.

1) Fill Out The Proper Forms

First, you’ll need to ensure your employees have filled out the proper forms. Your own employees will complete a W-4 form, which will let you know if they have any withholdings. You can use the IRS withholdings calculator to get a more accurate estimate. Meanwhile, independent contractors have to fill out a W-9 form.

Your employees should fill out a W-4 any time their personal and financial situation changes, including:

• Marriage or divorce
• Children
• Changes to household income (e.g., a second job)

2) Calculate Your Employee’s Gross Pay

Once all the paperwork is accounted for, it’s time to break out the calculator and spreadsheets and dive into how to figure out payroll for your employees.

Calculating gross pay is step number one. In short, gross pay can be thought of as the total money earned by an employee before deductions and taxes are factored in. To arrive at the correct total, you’ll have to add up an employee’s total wages, salary, commission, tips, bonuses, and any other form of earnings. (Note: Independent contractors are responsible for handling their own taxes, so that’s one thing off your plate. Phew!)

Let’s break down how to calculate the various types of earnings that go into a W-2 employee’s gross pay for each paystub.

Salary

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

Hourly Wages

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

Overtime refers to pay for hours worked beyond a specific weekly threshold (often 40 hours). It’s important to note that not every employee is eligible for overtime. Hourly employees receive overtime for hours worked beyond 40, whereas exempt salaried employees do not qualify for overtime if they make $35,568 or more annually (or $684 per week). Check out this fact sheet from the US Department of Labor if you’re unsure how to classify your employees.

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

Tips

Some workers, especially in the foodservice industry, receive tips from customers. These are taxable wages that must be calculated and reported for payroll. Regulation varies by state and industry, but some portion of tips may be counted toward meeting minimum wage requirements. Let’s use the example of a foodservice worker making minimum wage ($15/hour) in New York City. There are two ways to calculate this:

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

Commission

A commission represents a percentage from a sale or transaction that an employee receives as earnings. Often, employees who earn a commission receive it in addition to a base salary or hourly wage. This income is taxable. 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.

3) Withhold Federal & State Income Tax

Now that each employee’s gross pay is determined, it’s time to begin checking off which payroll taxes and deductions need to be withheld from their paycheck.

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. You should consult this form closely, whether you’re using the wage bracket or percentage method. If an employee’s withholdings haven’t changed since prior to 2020, you can use the previous version of the table.

As for state income taxes, you can visit your state’s government website to determine your state’s payroll tax rates or to learn whether your business operates in one of nine states that do not levy an income tax.

Wage Bracket Method

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

• Married filing jointly
• Single head of household
• 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 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.

4) Deduct Social Security

Employers must pay half of Social Security taxes themselves and withhold the other half from their employees’ paychecks. This is one of the easier calculations, as the Social Security tax has a fixed rate.

As of 2022, the Social Security tax is not deducted on incomes exceeding $147,000. This amount changes annually, so be sure to find up-to-date information.

If you hire your own children under the age of 18 to help out at your small business, there is an additional step. Specifically, you have to deduct their pay when calculating the Social Security withholding.

5) Deduct Medicare

Like Social Security, Medicare follows a fixed rate, and its payment is divided evenly between employers and employees.

6) Factor In Any Other Deductions

After you’ve covered income taxes, Social Security, and Medicare, there may be more deductions you’ll need to make from employees’ pre-tax gross pay. Deductions may be mandatory or voluntary. Here are some possibilities that may apply:

• 401(k) Contributions: Payments made toward a 401(k) or retirement fund are deducted because they aren’t taxable.
• Child Support: You will receive a notification from the court if this deduction applies to an employee
• Health Insurance: A deduction is made for the amount an employee contributes to their own health, dental, vision, or other medical insurance.
• Life Insurance: This voluntary deduction goes towards the employer’s cost of paying for coverage.
• Reimbursements: Payments for meals, mileage, per diem, lodging, etc., are nontaxable and should be deducted.

7) Calculate Net Pay

The net pay is what remains after all of the withholdings and deductions. This is the amount paid to employees through direct deposit or physical paycheck.

8) Cut The Checks

The arithmetic is finally behind you! Now, it is time to pay your employees their net earnings. While direct deposit is the most popular payment method in the US, paying by paper checks hasn’t died out yet.

Writing the checks by hand could be a way to keep costs down further, assuming you have the time to do so for all your employees. Otherwise, it may be worth looking into payroll software to save precious time and reduce human error.

The Best Way To Simplify Calculating Payroll & Payroll Taxes

Manually calculating payroll and payroll taxes can be time-consuming, and making costly mistakes is easy. Moreover, as your business grows, manually handling payroll becomes even more inefficient, especially when you consider the option to automate and streamline the payroll process with payroll software.

With payroll software, you can input employee information, including pay rates, pay schedules, tax filing status, and preferred payment methods. From there, payroll software can automatically calculate employee and contractor pay, track employee time, calculate and withhold payroll taxes, handle deductions, and much more.

In short, the right payroll software can save your business time and make running payroll easy, from your first FICA tax payment to calculating employee bonuses.

The Bottom Line On How To Calculate Payroll Taxes

Calculating payroll taxes is an essential part of the payroll process, even if your business uses payroll software. As an employer, your payroll tax responsibilities are two-fold; you have to withhold the right amount of taxes from employee paychecks and pay your business’s payroll tax liabilities on time.

It can be challenging to handle payroll taxes manually. We recommend investing in a payroll software solution that can help you keep everything organized, automate payroll tax calculations and payments, and ensure that your employees are paid on time with the right amounts withheld.

However, it’s always best to trust professionals when it comes to taxes. Your business’s accountant can help you ensure that you’re staying compliant with payroll tax laws. Better yet, a business accountant can point you in the right direction regarding payroll software.

If you’re ready to take the dive into your business’s payroll operations, check out the following resources:

• The beginner’s guide to creating a payroll budget
• The best free payroll software options for small businesses
• The best payroll practices for small businesses

How To Calculate Payroll Taxes FAQs