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

 

Form W-4: Employee’s Withholding 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 their wages. The employee will enter their name, address, and social security number.

 

The W-4 has been revised for 2020. The new form has a five-step process and new Publication 15-T (Federal Income Tax Withholding Methods) for determining employee withholding. It no longer uses withholding allowances.

 

If your employee was hired in 2019 or prior, you can continue to use the information they provided on the old W-4. It includes a worksheet that allows your employees to calculate withholding allowances for dependents and children. Some employees may want to fill out a new 2020 W-4 if they work a second job, get married, have a child, or get divorced, but you cannot require your employees to complete a new one.

 

Employees can also elect to have additional tax withheld or request to be exempt from federal income tax withholding. The new form W-4 provides detailed instructions.

 

Make sure the employee signs the W-4, but don’t send 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.

 

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.

 

If you’re trying to figure out a specific step, feel free to skip to the one you’re looking for:

 

 

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, his 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 any additional hours 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 taxes. In most states, you’ll need to withhold for both federal and state taxes and FICA taxes from each paycheck.

 

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

 

 

Federal Income Tax (FIT): 2019 or prior

Federal Income Tax (FIT) is calculated using the information from an employee’s completed W-4, their taxable wages, and their pay frequency. Based on Publication 15-T (2020), Federal Income Tax Withholding Methods, you can use either the Wage Bracket Method or the Percentage Method to calculate FIT.

 

We will use the Percentage Method in our example, looking at tables found in the 2020 IRS Publication 15-T PDF file. You can open the file to follow our calculations below.

 

Using Worksheet 1 on page 5, we will determine how much federal income tax to withhold per pay period.

 

 

Step 1. Adjust the employee’s wage amount

 

1a) This is the same as gross wages: $2,083.33.

1b) Our employee is paid semi-monthly or 24 times per year.

1c) This should equal your employee’s annual salary: $2,083.33 x 24 = $50,000

 

Because we are using the 2019 W-4 form, we now skip to step 1j:

 

1j) Our employee has claimed 2 allowances

1k) $4,300 x 2 = $8,600

1l) $50,000 – $8,600 = $41,400

 

To continue, you will need to refer to the tax tables on page 6:

 

Step 2: Figure the tentative withholding amount

 

2a) This amount is from line 1l, $41,400

2b) We are referring to the table labeled “Single or Married Filing Separately” on the left (the form is from 2019 or earlier). Our employee’s adjusted annual wage amount is greater than $13,675 and less than $43,925 ($41,400). So, we would enter an amount of $13,675 (the amount from column A).

2c) The amount in column C is $987.50.

2d) The percentage from column D is 12%.

2e) $41,400 – $13,675 = $27,725

2f) $27,725 x 12% = $3,327

2g) $987.50 + $3,327 = $4,314.50

2h) $4,314.50 / 24 = $179.77

 

Step 3: Account for tax credits

 

3a) $0

3b) $0

3c) $179.77 – $0 = $179.77

 

Step 4: Figure the final amount to withhold

 

4a) $0 (there are no additional withholdings in this case)

4b) $179.77 + $0 =  $179.77

 

There you have it. You will withhold $179.77 of federal income tax for this employee using the W-4 from 2019 and earlier.

 

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Federal Income Tax (FIT): 2020 or after

Federal Income Tax (FIT) is still calculated using the information from an employee’s completed W-4, their taxable wages, and their pay frequency. In fact, not much has changed until you get into the withholding math. Looking at Publication 15-T (2020), Federal Income Tax Withholding Methods, 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 2020 IRS Publication 15-T PDF file. You can open the file to follow our calculations below.

 

Using Worksheet 1 on page 5, we will determine how much federal income tax to withhold per pay period.

 

 

Step 1. Adjust the employee’s wage amount

 

1a) This is the same as gross wages, so as we calculated before, the amount is $2,083.33.

1b) Our employee is paid semi-monthly or 24 times per year.

1c) This should equal your employee’s annual salary: $2,083.33 x 24 = $50,000

 

Because we are using the 2020 W-4 form, we would now continue to step 1d:

 

1d) Our employee does not have any additional income, so this amount is $0.

1e) $50,000 + $0 = $50,000

1f) We are only withholding standard deductions so this equals $0.

1g) We would not check the box because our employee does not have more than one job, and because she claims a single marital status, this amount is $8,600.

1h) $8,600 + $0 = $8,600

1i) $50,000 – $8,600 = $41,400

 

To continue, you will need to refer to the tax tables on page 6:

 

Step 2: Figure the tentative withholding amount

 

2a) This amount is from line 1i, $41,400

2b) We are referring to the table labeled “Single or Married Filing Separately” on the left (using the 2020 W-4 and the box in step 2 is not checked). Our employee’s adjusted annual wage amount is greater than $13,675 and less than $43,925 ($41,400). So, we would enter an amount of $13,675 (the amount from column A).

2c) The amount in column C is $987.50.

2d) The percentage from column D is 12%.

2e) $41,400 – $13,675 = $27,725

2f) $27,725 x 12% = $3,327

2g) $987.50 + $3,327 = $4,314.50

2h) $4,314.50 / 24 = $179.77

 

Step 3: Account for tax credits

 

3a) Our employee is claiming two dependents, each worth $2,000. $2,000 x 2 = $4,000

3b) $4,000 / 24 = $166.67

3c) $179.77 – $166.67 = $13.10

 

Step 4: Figure the final amount to withhold

 

4a) $0 (there are no additional withholdings in this case)

4b) $13.10 + $0 =  $13.10

 

There you have it. You will withhold $13.10 of federal income tax for this employee based on the new Form W-4.

 

This is a significant difference from the previous W-4 withholding amount of $179.77 but is designed to help your employees have a more accurate amount of tax withheld from each paycheck.

 

 

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 $137,700.00 for the 2020 tax year. Any annual wages above $137,700.00 are exempt, which means that the cumulative annual Social Security withholding cannot exceed $8,537.40. 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 using the 2019 W-4 or prior:

 

  • 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 $179.77 using the old W-4.
  • Social Security tax is $129.17, and Medicare tax is $30.21. The 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 $1,744.18.

Let’s review our example using the 2020 W-4 or after:

 

  • 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 $13.10 using the new W-4.
  • Social Security tax is $129.17, and Medicare tax is $30.21. The 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 $1,910.85.

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 x 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 x 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.

 

 

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