Understand all the basics of payroll tax withholding in just a few minutes. Our detailed guide has all the answers for small business owners.
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Payroll tax withholding for employers: 7 steps before writing a paycheck

If you’re struggling to sort out the various employment and payroll taxes that you’re responsible for as a small business owner, you’re definitely not alone. It’s complex and can feel very overwhelming. But we’re here to help you check off the seven things you have to do before writing your first paycheck.

 

Let’s start at the beginning: What is withholding? The IRS requires any business with employees to withhold certain taxes from employees’ paychecks, then deposit them with state and federal entities. Federal withholding rates can vary from employee to employee based on the information provided on their W-4 (more on that later), but the FICA taxes for Social Security and Medicare are calculated using a set formula for all staffers. So, the first step for you is to get the employee-specific withholding information you need.

 

Step 1: All new employees need to fill out a W-4 on their first day of work

You must receive a completed W-4 form from each employee before payroll is processed so that the correct amount of federal tax is withheld from their paycheck. Complete instructions are included with the form, including guidance for those with multiple jobs or a working spouse. The form also includes a Personal Allowances Worksheet, which allows employees to accurately determine how many allowances they should claim.

 

The W-4 worksheet also allows employees to calculate child tax credits, as well as any additional allowances for dependents. Those in a two-earner family can calculate additional taxes to withhold, and employees with a second job can also use the worksheet to determine if more taxes should be withheld and, if so, how much..

 

If you don’t receive a completed W-4 from your employee, the IRS requires that you withhold taxes as if the employee was single with zero allowances. Remember, you can’t help employees fill out their W-4 or advise them on what deductions to choose.

 

Don’t forget! Hang onto those W-4s — or W-9s

A completed W-4 must be kept on file for all employees. They do not expire, however employees can choose to update their information with different allowances at any time. It’s important to note that only employees are required to fill out a W-4. Anyone hired as a contractor should fill out  a W-9 to ensure that you have the information needed to process their 1099 at the end of the year.

 

Step 2: Determine gross pay

Next, you’ll calculate the employee’s gross wages before determining the amount of taxes that should be withheld.

 

For hourly employees:

 

  • Calculate employee base pay by the number of hours worked. For example, 80 hours x $10.00 per hour would be $800.00.
  • Overtime hours are typically calculated at time and a half, so five hours of overtime would be calculated as 5 x $10.00 x 1.5 = $75.00. For an employee who works 80 hours, plus five hours of overtime at $10 per hour, that would make their gross pay: $800.00 + $75.00 = $875.00.

For salaried employees:

 

  • Salaried employees are paid the same each pay period. For a twice-monthly pay period, an employee making $40,000 a year would receive $40,000, divided by 24 annual pay periods, making their gross wages for the pay period $1,666.67.

Step 3: Calculate federal withholding based on gross pay

Once you have an employee’s gross pay calculated, you can then determine federal withholding. Here’s where that W-4 comes into play: You’ll look at the withholdings they chose, including any additional taxes that they asked to be deducted.

 

You’ll need to access the IRS tax tables for 2019  in order to calculate everything accurately, or you can use trusted payroll software or a payroll calculator to do the math for you.

 

Step 4: Calculate FICA contributions

Next, you’ll calculate FICA payroll taxes. FICA is a combination of Social Security and Medicare, and both the employer and the employee contribute to them. You will withhold a total of 7.65 percent, including 6.2 percent for Social Security and 1.45 percent for Medicare. Please note, employers must withhold Social Security taxes until the employee earns at least $117,000 in a year. There is no income limitation for Medicare taxes.

 

To calculate FICA, use the following for hourly or salaried employees:

 

  • For gross pay of $875.00, multiply 875 x 6.2% = $54.25 for Social Security tax
  • For Medicare tax, multiply $875.00 x 1.45% = $12.69
  • The total FICA to be withheld for this pay period is $54.25 + $12.69 = $66.94

In addition to Social Security and Medicare taxes, employees who earn in excess of $200,000 annually will also pay a 0.9 percent Medicare surtax, which will be withheld from their checks in addition to the other FICA taxes.

 

Step 5: Match employee contributions for FICA

In addition to withholding FICA taxes from employee wages, employers are also responsible for matching the amount of FICA taxes withheld, so if $66.94 was deducted from your employee, you’ll need to match that amount and deposit the funds in a timely manner.

 

Step 6: Calculate state and local taxes

Depending on where your business is located, state and local taxes may also need to be calculated. Don’t forget to send in those local taxes to the appropriate agency.

 

Step 7: Deposit federal, state and local taxes on time

Tax deposit schedules vary by state, with many requiring a quarterly deposit, so check with your local agencies to determine what your schedule will be. For the federal government, there are currently two deposit schedules; monthly and semi-weekly. Business owners will be notified at the beginning of the year what deposit schedule they need to use.

 

Whether you process payroll in-house or use a payroll service provider, it is up to you to ensure that taxes are calculated properly and paid on or before their due date. Businesses that fail to make timely  deposits may be subject to a 15 percent penalty plus the interest charged on any outstanding taxes due.

 

While it may seem overwhelming, withholding and paying taxes is a fairly straightforward process. For more answers, check out our complete guide to processing payroll, or take a look at the IRS website to review their Employer’s Tax Guide.

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