Make payroll mistakes a thing of the past. These step-by-step instructions to calculate employer payroll taxes (plus tax rates) will help you get it right.
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How to calculate payroll taxes, step by step

If you’re a small business owner trying to figure out how to calculate payroll, you’re not alone. Over six million small businesses in the U.S. are in the same boat as you. They all have fires to put out, employees to pay, futures to plan, and little to no time to grapple with the IRS tax code.

 

The good news is that although the tax code may seem complicated, once you figure out what tax filings are required and learn how to do the math, the process is fairly straightforward. With that being said, calculating payroll taxes correctly is critical not only to your employees, but also to your accountant and Uncle Sam. That’s why we decided to write this in-depth guide on how to calculate payroll taxes, step by step.

 

You should be able to find all the answers to your payroll questions here, but if you hit a wall or simply want to take payroll taxes off of your to-do list, we also offer a simple payroll service that does the heavy lifting for you.

 

Before you hit the ground running, though, you first need to gather some information from your employees. Then, after you complete employee payroll calculations, you’ll need to do a couple more things to tie up loose ends. We’ve broken down all the pertinent information into four sections, so feel free to skip ahead if you have a specific question you’re trying to answer:

 

Before You Run Payroll

Before you can begin calculating payroll taxes, your employees will need to complete these new employee documents, which include:

 

  • Form W-4: Employee’s Withholding Allowance Certificate
  • State W-4 (as applicable)
  • Direct Deposit Authorization Form
  • Form I-9: Employment Eligibility Verification

 

Form W-4: Employee’s Withholding Allowance Certificate

Each new employee must complete the IRS Form W-4, which tells you key information about how much federal income tax (FIT) you’ll need to withhold from each employee’s wages. The employee will enter their identifying information, such as name, address, and social security number.

 

The employee must also state their tax filing marital status and determine the number of allowances (head of household, child tax credit, other dependents, etc.). The more allowances the employee claims, the less tax you will need to withhold. We’ll get into the specifics of the calculation in the next section.

 

Employees can also elect to have additional tax withheld, or claim to be exempt from federal income tax withholding. Form W-4 provides detailed instructions.

 

Make sure the employee signs the W-4, but don’t submit it to the IRS unless requested. Retain it in your employee’s personnel file for a minimum of 4 years after the date of the employee’s latest tax return.

 

Also, keep in mind that employees can update their W-4 allowances as often as necessary, especially after life events such as getting married or having kids. Employees who claim to be exempt from income tax withholding must complete a new W-4 each year.

 

State W-4 (as applicable)

Some states have their own withholding forms. For states that don’t, the Form W-4 will often be used as the basis for calculating state and/or local income tax withholding. A complete list of applicable state tax forms can be found at the Federation of Tax Administrators website.

 

Direct Deposit Authorization Form

As an employer, you can pay your employees several different ways: paper check, direct deposit, prepaid debit card, or cash. Direct deposit is often the easiest and securest way to do things, which is why it is by far the most popular. In fact, more than 82% of US workers are now being paid by direct deposit.

 

An employee who chooses to be paid by direct deposit must fill out a direct deposit authorization form, complete with bank routing numbers and account numbers. The form acts as a permission slip for you to deposit the employee’s net pay electronically into their bank account.

 

As part of the verification process, many employers will ask for a voided blank check to confirm the accuracy of the bank account information provided by the employee.

 

Form I-9: Employment Eligibility Verification

New employees fill out a Form I-9 to certify that they are legally permitted to work in the United States (i.e. as a citizen, permanent resident, work visa holder, etc.). They can prove their work status by either providing you their US passport or both their driver’s license and Social Security card.

 

You are required by law to obtain a signed Form I-9 from your employee before employment commences. You should retain the completed form and any supporting documents in your employee’s personnel file.

 

Best Practice

You might also want to have new employees acknowledge their receipt of the company handbook, code of conduct, and any other formal policies at this time. While the acknowledgment isn’t necessary for payroll calculations, it’s a best practice to have your new employees complete all required company forms at the same time. HR software can make it easy to manage all these tasks.

 

Calculating Employee Payroll Taxes in 5 Steps

Once your employees are set up (and your business is set up, too), you’re ready to figure out the wages the employee has earned and the amount of taxes that need to be withheld. And, if necessary, making deductions for things like health insurance, retirement benefits, or garnishments, as well as adding back expense reimbursements.

 

In technical terms, this is called going from gross pay to net pay.

 

Step 1: Figure Out Gross Pay

Gross pay is the original amount an employee earns before any taxes are withheld.

 

For hourly employees, gross pay is the number of hours worked during the pay period multiplied by the hourly rate. For example, if your receptionist worked 40 hours a week at a rate of $20 an hour, their gross pay for the week would be 40 X $20, or $800.

 

Don’t forget to include any overtime pay, which is typically 1.5 times the normal pay rate when an hourly employee works more than 8 hours a day or 40 hours a week. In this example, your receptionist would earn $20 for each of the first 40 hours worked, plus $30 for the 41st and each ensuing hour during the week.

 

For salaried employees, who are exempt from the overtime rules, gross pay will generally remain unchanged each pay period. Simply divide their salary by the number of pay periods in a year. For example, if a manager earns an annual salary of $50,000 and receives a paycheck twice a month, gross pay each pay period is $2,083.33 ($50,000 / 12 months / 2 monthly pay periods).

 

In addition to wages, gross pay includes any commissions, tips, and bonuses the employee earns.

 

Step 2: Calculate Employee Tax Withholdings

Once you know an employee’s gross pay and the number of allowances from their W-4, you can start figuring out how much you need to withhold to cover their tax obligations. In most states, you’ll need to take both federal and state taxes, as well as FICA taxes, out of each paycheck.

 

In our example, we will use a Florida employee who claims single marital status and 2 allowances on their W-4. The employee earns a $50,000 annual salary and is paid twice a month (semi-monthly). Thus, gross pay per period is $2,083.33.

 

Federal Income Tax (FIT)

Federal Income Tax (FIT) is calculated using the inputs from an employee’s completed W-4, their taxable wages, and their pay frequency. Per Publication 15 (2019), (Circular E), Employer’s Tax Guide, you can use either the Wage Bracket Method or the Percentage Method to calculate FIT.

 

We will use the Percentage Method in our example, referencing tables that are found in the 2019 IRS Publication 15 PDF file. Please open the file to follow our calculations below.

 

  1. We first have to identify how much each allowance reduces the employee’s taxable wages by. Table 5 on page 45 tells us that for semi-monthly payroll periods, each withholding allowance is valued at $175.00.

    Table 5. Percentage Method – 2019 Amount for One Withholding Allowance

    Payroll Period One Withholding Allowance
    Weekly $80.80
    Biweekly $161.50
    Semimonthly $175.00
    Monthly $350.00
    Quarterly $1,050.00
    Semiannually $2,100.00
    Annually $4,200.00
    Daily or miscellaneous $16.20

     

    Multiply $175.00 by 2 to get $350.00, the amount you can exclude from gross income before calculating withholding tax.

     

    $175.00 x 2 = $350.00

  2. Take the employee’s semi-monthly pay of $2,083.33 and subtract it by $350.00. You are left with income subject to withholding tax.$2,083.33 – $350.00 = $1,733.33
  3. We now need to look at another table to complete our calculation. For our single employee, we need to reference the left-hand column of Table 3 – Semi-Monthly Payroll Period on page 46.

    Table 3 – Semimonthly Payroll Period

    (a) SINGLE person (including head of household) –
    The amount of wages (after subtracting withholding allowances) is: The amount of income tax to withhold is:
    Not over $158 $0
    Over – But not over –
    $158 -$563
    $563 -$1,803
    $1,803 -$3,667
    $3,667 -$6,855
    $6,855 -$8,663
    $8,663 -$21,421
    $21,421
    of excess over –
    $0.00 plus 10% -$158
    $40.50 plus 12% -$563
    $189.30 plus 22% -$1,803
    $599.38 plus 24% -$3,667
    $1,364.50 plus 32% -$6,855
    $1,943.06 plus 35% -$8,663
    $6,408.36 plus 37% -$21,421
    (a) MARRIED person
    The amount of wages (after subtracting withholding allowances) is: The amount of income tax to withhold is:
    Not over $492 $0
    Over – But not over –
    $492 -$1,300
    $1,300 -$3,781
    $3,781 -$7,508
    $7,508 -$13,885
    $13,885 -$17,500
    $17,500 -$26,006
    $26,006
    of excess over –
    $0.00 plus 10% -$492
    $80.80 plus 12% -$1,300
    $378.52 plus 22% -$3,781
    $1,198.46 plus 24% -$7,508
    $2,728.94 plus 32% -$13,885
    $3,885.74 plus 35% -$17,500
    $6,862.84 plus 37% -$26,006
  4. Using the “Over” and “But not over” columns, we see that our employee’s adjusted taxable income of $1,733.33 fits in the “over $563, but not over $1,803” range.Thus, our employee’s tax withholding will be “$40.50 plus 12% of excess over $563.”
  5. Let’s first calculate the “12% in excess of $563.”Take $563 from the “of excess over” column, subtract it from the adjusted taxable income, and multiply the resulting number by 12%.($1,733.33 – $563.00) x 12% = $140.44
  6. We then add this number to $40.50.$140.44 + $40.50 = $180.94

There you have it. We will withhold $180.94 of federal income tax for this employee.

 

FICA Taxes

The Federal Insurance Contributions Act (FICA) is comprised of Social Security and Medicare, two taxes that are required to be withheld from all employees unless otherwise exempt.

 

  • Social Security is a flat 6.2% withholding tax for wages up to $128,400.00 for the 2018 tax year. Any annual wages above $128,400.00 are exempt, which means that the cumulative annual Social Security withholding cannot exceed $7,960.80.For our example employee, we would take their gross wage of $2,083.33, multiply it by 6.2%, and withhold $129.17 from their paycheck.
  • Medicare is also a flat tax, at a rate of 1.45%. There is no annual limit for Medicare taxes, but employees who earn more than $200,000 a year are subject to what’s called the Additional Medicare Tax of 0.9%.We multiply our employee’s gross wage of $2,083.33 by 1.45% and arrive at $30.21 for Medicare tax.

Our employee’s FICA tax per pay period is thus $129.17 + $30.21 = $159.38.

 

State and Local Taxes

Some states (like Florida) have no state income taxes, so you may be off the hook. But if you’re required to pay state taxes (see state-by-state tax info here), you’ll want to make sure your calculations are done right.

 

Different states apply payroll taxes in different ways, but once you know how to calculate the FIT and FICA taxes, calculating state taxes is a similar exercise.

 

Also be sure to check whether your state imposes local taxes that are paid on top of federal and state taxes.

 

Step 3: Take Care of Deductions

In addition to withholding for payroll taxes, calculating your employees’ paycheck also means taking out any applicable deductions.

 

There are voluntary pre and post-tax deductions like health insurance premiums, 401(k) plans or health savings account contributions. Some employees also have involuntary deductions that may need to be considered for items like child support or wage garnishments (you’ll know if you need to withhold these things because you’ll receive an order from a judge, the IRS, or the state).

 

Be careful here, because pre-tax deductions like 401(k) are taken out of gross income in Step 1, which means that the tax withholding calculation in Step 2 will be lower. Post-tax deductions are taken out after Step 2. Pre-tax deductions will save the employee more taxes.

 

Step 4: Add on Any Expense Reimbursements

If your employee paid for any company expenses out of their own pocket, they expect to be reimbursed. Employers can either pay reimbursements separately from payroll or combine it with payroll.

 

Remember that expense reimbursements are not part of gross wages, and thus not subject to tax withholding. Any expenses you reimburse to employees should be made in full and added on to net pay at the end of your calculation.

 

Step 5: Add It All Up

Once you’ve done all the math to figure out gross pay, tax withholdings, deductions, and reimbursements, you’ll have what you need to calculate the paycheck:

 

  • Start with gross pay
  • Subtract employee tax withholdings
  • Subtract deductions
  • Add on any expense reimbursements
  • And you get net pay!

Now you know exactly how much money you will send your employee on payday!

 

Let’s review our example:

 

  • Our employee earns $50,000 a year, or $2,083.33 of gross pay per semi-monthly pay period.
  • Our employee’s federal income tax withholding is $180.94.
  • Social Security tax is $129.17, and Medicare tax is $30.21. Total combined FICA tax is $159.38.
  • Since our employee lives in Florida, there is no state income tax withholding.
  • There were no deductions or expense reimbursements.
  • Thus, our employee’s net pay is $1,743.01.

From time to time, there may be other things you’ll need to add (like bonuses) or deduct (like garnishments and levies) from your employees’ paychecks. When these items are added and subtracted, the rest of the basic math outlined above stays the same.

 

Calculating Employer Payroll Taxes

In addition to the taxes you withhold from an employee’s pay, you as the employer are responsible for paying certain payroll taxes as well:

 

  • FICA Matching: You are required to match the employee’s FICA tax withholding, which means your company will pay 6.2% tax for Social Security and 1.45% tax for Medicare.Using our example employee, you as the employer would pay a matching $129.17 for Social Security and $30.21 in Medicare, resulting in a $159.38 FICA obligation.
  • Unemployment Taxes: You will also have to pay federal and state unemployment tax. Unemployment taxes are paid only by the employer, not the employee.
    • Federal Unemployment Tax (FUTA) is 6.0% of the first $7,000 in wages you pay each employee each year. If your company is subject to state unemployment, you can receive a federal tax rate credit of up to 5.4%, which makes the effective tax rate 0.6%. Once an employee earns more than $7,000 in a calendar year, you stop paying FUTA for that employee in that tax year. Federal Unemployment: $2,083.33 * 0.6% = $12.50
    • State Unemployment Tax (SUTA) varies by state. Consult with your state’s Department of Labor or Unemployment Revenue for tax rates, wage bases, and filing requirements.For this example, we will assume the employee has not yet been paid $7,000 year-to-date. We will use Florida’s unemployment tax rate of 2.7%.State Unemployment: $2,083.33 * 2.7% = $56.25

Thus, your obligation as the employer during this pay period is $129.17 + $30.21 + $12.50 + $56.25, which comes out to a total of $228.13.

 

Making Payments to the IRS

Just because you’ve calculated payroll and paid your employees doesn’t mean your job is done. You also need to send the taxes you withheld (i.e. FIT, FICA, state and local income taxes) to the respective taxing authority. For FIT and FICA, that is the IRS. For state and local income taxes, that is your state’s withholding tax agency.

 

Be sure to send both the taxes you withheld from your employee’s paycheck as well as the taxes that you as the employer are responsible for.

 

The timing of when you send the federal taxes depends on how much you pay employees, how frequently you pay them, and your lookback period (historical analysis of your payroll and past payments). The IRS Form 941, Employer’s Quarterly Federal Tax Return, provides details on how, when, and where to pay FIT and FICA.

 

The deadline to file Form 941 is the last day of the month following the end of a calendar quarter. For example, for the quarter ending on March 31st, Form 941 is due on April 30th. There are significant penalties for not filing this form, so don’t forget!

 

For state tax filings, you should contact your state’s withholding tax agency for filing requirements for state and local income tax rates. Each state is different.

 

 

One Last Thing!

Good luck calculating those payroll taxes (and building your team)! If you ever have any questions, or feel like you might want to leave this particular action item to someone else, we make payroll really easy. Take a peek.

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