How To Calculate Payroll

The best payroll software can calculate wages, taxes, and deductions automatically, but it’s still useful for business owners to understand how payroll calculations work.

This guide explains the basics of calculating payroll, including gross pay, payroll taxes, deductions, and net pay.

What Is The Formula For Calculating Payroll Taxes?

The basic formula for calculating a payroll tax is:

(Taxable Wages) X (Payroll Tax Rate) = Payroll Tax Liability

Convert each payroll tax percentage to a decimal before multiplying. For example, 6.2% becomes 0.062.

You’ll need to calculate each payroll tax separately, including Social Security, Medicare, federal income tax withholding, and any applicable state or local payroll taxes. After calculating taxes and deductions, subtract the employee’s withholding and deductions from gross pay to determine net pay.

What To Know Before Calculating Payroll

Before calculating payroll manually, gather the information you’ll need to calculate wages, taxes, and deductions accurately. This includes each employee’s pay rate, hours worked, Form W-4, pay schedule, benefits deductions, and any applicable state or local payroll tax requirements.

How To Calculate Payroll in 6 Steps

To calculate payroll, start with an employee’s gross pay, then subtract the correct taxes, deductions, and garnishments to arrive at net pay.

Step 1: Calculate The Employee’s Gross Pay

Gross pay is the total amount an employee earns before taxes and deductions are withheld. It may include wages, salary, tips, overtime, bonuses, commissions, and other taxable earnings.

Step 2: Add Supplemental Earnings

Supplemental earnings are wages paid in addition to regular hourly or salaried pay. These may include:

• Overtime
• Bonuses
• Tips
• Commissions
• Severance pay
• Certain taxable fringe benefits

Overtime, tips, bonuses, and commissions may have different payroll rules, so employers should confirm how each type of pay should be taxed and reported.

Step 3: Calculate Payroll Taxes

Next, calculate required payroll taxes. These may include:

• Federal income tax withholding
• State and local income tax withholding
• Social Security tax
• Medicare tax
• Federal unemployment tax
• State unemployment tax
• Other state or local payroll taxes

Federal income tax withholding is not simply gross pay multiplied by one tax bracket. Employers generally calculate federal withholding using the employee’s Form W-4, pay frequency, taxable wages, and IRS Publication 15-T wage bracket or percentage method tables.

IRS Publication 15-T explains both the wage bracket method and percentage method.

Step 4: Calculate Federal Payroll Taxes

Federal payroll taxes include Social Security, Medicare, and FUTA.

• Social Security Tax: Employees and employers each pay 6.2% up to the annual Social Security wage base. For 2026, the wage base is $184,500.
• Medicare Tax: Employees and employers each pay 1.45%, with no wage base limit. Employers must withhold an additional 0.9% Medicare Tax on wages paid to an employee above $200,000 in a calendar year.
• FUTA Tax: Employers pay federal unemployment tax. FUTA is generally 6% on the first $7,000 of wages paid to each employee, though eligible employers may receive a credit that lowers the effective rate.

Step 5: Subtract Pre-Tax & Post-Tax Deductions

After calculating wages and payroll taxes, subtract any applicable deductions.

Pre-tax deductions may include:

• Traditional 401(k) contributions
• Eligible health, dental, or vision premiums
• HSA or FSA contributions
• Certain commuter benefits

Post-tax deductions may include:

• Wage garnishments
• Roth 401(k) contributions
• Union dues
• Charitable contributions
• Certain insurance premiums or voluntary deductions

Some deductions affect income tax, FICA taxes, or both differently, so employers should confirm the tax treatment of each deduction before running payroll.

Step 6: Calculate Net Pay

To calculate net pay, subtract employee tax withholdings, deductions, and wage garnishments from gross pay.

(Gross Pay) – (Taxes + Deductions + Garnishments) = Net Pay

Net pay is the amount the employee receives through direct deposit or a paper check. It should appear on the employee’s pay stub alongside gross pay, taxes, and deductions.

Use Payroll Software To Simplify Payroll Calculations

Manually calculating payroll can be time-consuming, and mistakes can lead to underpaid employees, incorrect tax deposits, or payroll penalties. As your business grows, manual payroll also becomes harder to manage, especially if you have multiple pay rates, deductions, benefits, or state tax requirements.

Some small businesses handle payroll manually to save money, but affordable payroll software can automate wage calculations, payroll tax withholding, deductions, direct deposit, and tax filings.

The right payroll software can save time, reduce calculation errors, and make payroll easier to manage, from calculating FICA taxes to processing bonuses and deductions.

The Bottom Line On How To Calculate Payroll

As an employer, you’re responsible for withholding the correct taxes from employee paychecks, paying your share of payroll taxes, and making payroll tax deposits and filings on time.

Payroll software can help automate wage calculations, tax withholding, deductions, direct deposit, and payroll tax filings. This can reduce errors and make payroll easier to manage as your business grows.

Although payroll software is an investment, the benefits of payroll software can definitely outweigh any payroll software costs. If you don’t want to use payroll software, consider working with an accountant or payroll professional to make sure your payroll taxes are calculated, paid, and filed correctly.