Paying employees is one of a small business’s most important (and potentially costly) responsibilities, and having a payroll budget can help keep costs from getting unwieldy. Running payroll includes more than just salaries, though. It also accounts for state and federal payroll taxes to avoid penalties and unwanted attention from the Internal Revenue Service.
What you’ll learn
What you’ll learn
Updated: May 13, 2025
Key takeaways about creating a payroll budget
- A payroll budget includes salaries, taxes, benefits, and other costs that impact your total payroll expenses
- Creating a payroll budget helps you plan for payroll costs, manage cash flow, and stay compliant with tax regulations
- Adjusting your payroll budget periodically allows you to account for new hires, bonuses, raises, and other changes as your business grows
Priorities change over time, and labor can be one of the most challenging parts of your business to manage. This guide will help you create a payroll budget you can count on and keep your business compliant as the year progresses.
What is a payroll budget?
In simplest terms, a payroll budget is a projection of the complete cost of employing workers over a specific period. This includes costs for full-time, part-time, and temporary employees, and typically accounts for an individual pay period. Most employers pay their employees on a biweekly basis (every two weeks), so an appropriate payroll budget would account for the organization’s total labor cost for a two-week pay period. However, if you pay your employees monthly or weekly or on some other timeline, it’s important to create a budget that accurately reflects the timeframe you’re working within.
Now that we better understand how a payroll budget gets defined, let’s uncover some of the details of what goes into one.
“Managing employee compensation is a critical and often costly responsibility for most small businesses. A well-designed payroll budget can help ensure that payroll expenses remain under control.
In addition to calculating salaries and wages, employers must also account for federal and state payroll taxes and withholdings in order to avoid penalties or compliance issues with the Internal Revenue Service (IRS).”
— David Kindess, CPA
Essential components of a payroll budget
A payroll budget includes both fixed and variable costs, such as salaries and wages, payroll taxes, payroll processing fees, benefits costs, and more. When creating a payroll budget, you should factor in the following components:
- Identifying employee positions: Determining employee roles will help you identify full-time, part-time, and temporary employees you may not have to account for beyond the current pay period.
- Calculating salaries and wages: The largest part of a payroll budget is employee salaries, which should reflect salary or hourly status.
- Estimating overtime costs: If your organization pays overtime costs, you should account for potential overtime in your payroll budget.
- Accounting for payroll taxes: Businesses must pay payroll taxes, such as Social Security and Medicare assessments (FICA), and the Federal Unemployment Tax (FUTA). FICA is equivalent to 15.3% of an employee’s gross wage, but employers only pay 7.65% of that cost. FUTA is 6% on the first $7,000 of wages subject to the tax. If you’re wondering how to estimate payroll taxes for a budget, take a look at our guide to calculating payroll taxes.
- Including bonuses and incentives: Bonuses and incentives may not factor into every payroll budget, but if you’re offering some kind of temporary incentive or bonus, you should account for it in your budget.
- Estimating employee benefits: Costs for benefits like retirement contribution matches, healthcare insurance, and other benefits should factor into your calculations.
Ultimately, the average employee costs a business between 1.25 and 1.4 times their salary, so it’s important to properly budget beyond an employee’s base wages. Gathering historical data for your payroll records will help you plan your budget and forecast for the future, especially if you’re considering hiring new employees or offering new incentives.
Now that we better understand the different facets of a payroll budget, let’s learn more about how the number crunching comes together with David Kindness, a certified public accountant and OnPay subject matter expert with over a decade of experience helping small businesses.
How do you estimate payroll expenses?
“Estimating payroll expenses is the first and most important step in building a payroll budget,” explains David. “It involves calculating salaries and base wages, as well as additional costs such as taxes, benefits, paid leave, and other deductions.”
So, what do owners need to have in place to start off on the right foot? According to David, below is a step-by-step approach to help you estimate payroll expenses.
- List all employees: Start by creating a list of all employees. Include full-time, part-time, and temporary workers. For each employee, list their salary or hourly wage, expected hours of work, and pay frequency (generally either weekly, biweekly, monthly, or twice per month).
- Calculate gross wages: If the employee is paid hourly, multiply their hourly rate by the number of hours they are expected to work during the pay period. If they are paid a salary, divide their gross salary by the total quantity of pay periods throughout the year. Add up all employee’s gross wages to determine the total gross wages for the pay period.
- Add overtime and bonuses: Add any projected overtime or bonuses for the pay period. This can be based on historical averages, which you should then adjust for how busy the pay period is likely to be such as holidays or high-sales seasons, etc).
- Add employer-paid benefits: add amounts you expect to pay for things like health insurance, retirement contributions, paid leave, and any other fringe benefits (parking, gym memberships, travel expenses, etc.
- Add payroll taxes: Add amounts you expect to pay for payroll taxes, including Social Security and Medicare (FICA) and unemployment tax (FUTA). Also include state payroll taxes such as state unemployment tax (SUTA).
- Review and adjust: Once you have your total expected payroll expense, it’s important to regularly compare your estimates against actual payroll data to identify discrepancies and refine your calculations for future budgets. You can also compare your newly created budget with historical data to determine its reasonableness. It’s also important to update your budget to account for payroll changes such as raises, additional bonuses, new hires, terminations, etc.
Now that we better understand how the numbers come together, let’s see how to put it all together in a plan.
How to create a payroll budget (with examples)
By creating a proactive payroll budget, business managers can save time and prepare for changes in their workforce or organizational structure. Here are some tips for creating a reliable budget for payroll expenses.
- List all employees included in the payroll: The most important step in how to calculate a payroll budget is to gather a complete list of all employees who will be paid during a specific pay period.
- Identify the payroll components: Break down every employee by pay type, be it regular salary, regular hourly wages, bonuses, commission, overtime pay, and any other type of compensation.
- Analyze expenses for each employee or function: Different employees may be paid in different ways, and their compensation may change throughout the year. It’s important to ensure your payroll budget reflects changes from bonuses, overtime pay, commissions, and other variable costs. This is where historical data is particularly useful.
- Forecast new hiring needs: Compare your current staff to your future goals. If you need to hire new workers to accomplish your goals for the upcoming year, it’s important to build those costs into your budget.
- Review and set a budget: A good payroll budget has some cushion to change as your company grows or employees outperform expectations. Using all of the data you have available, you can calculate an effective annual payroll budget by including each employee’s annual pay, payroll taxes, benefit costs, expected additional compensation, and payroll processing costs.
Now that we have an in-depth list of the moving parts, we caught up with David once more to get his two cents on where payroll costs tend to end up.
What percentage of budget should be payroll?
“Generally speaking, it’s good practice to keep payroll at no more than 30% of a company’s gross revenue. That said, in certain industries, like service businesses, payroll costs may rise to as much as 50% of gross revenue without having a major impact on profitability. That’s because service-based businesses depend on large workforces to deliver the experience necessary to keep clients coming back (and spending more).”
— David Kindess, CPA
Additionally, many companies opt to run payroll budgets on a per-project basis, especially if they’re bringing in consultants or temporary workers to support existing employees. These short-term payroll budgets can give your organization even more flexibility when it comes to hiring.
Having a payroll budget can help your bottom line
A well-planned payroll budget provides more than just financial clarity — it creates a foundation for sustainable business growth. By keeping a close watch on what you’re investing in staffing, you can make informed decisions about optimizing your workforce and identifying opportunities for greater efficiency. Budgeting can also come in handy as you plan for recruiting efforts, allocate resources for employee benefits packages, and even keep you ahead of payroll tax obligations.
While managing payroll is rarely a set-it-and-forget-it consideration, modern payroll software makes this process much more manageable. As you keep scaling your business, our team would be happy to answer any questions you might have!
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.