Calculating your employees’ gross pay is just the first step in the lengthy process of running payroll. Employers must also calculate, withdraw, hold in trust, and file payroll taxes, then provide both the IRS and employees with the correct tax-filing paperwork on a regular schedule.
Using the right payroll software can dramatically simplify payroll processing while reducing your risk of making costly payroll mistakes. With several free or cheap payroll software options, it’s fairly easy for business owners to find an automated payroll service.
Whether you would like to know more about calculating payroll taxes generally, or you want to try running payroll by hand, our general overview can help you get started.
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What are payroll taxes?
Payroll taxes is a broad term for taxes employers deduct and file on behalf of their employees. It can also include taxes employers are required to pay based on the number of employees they have and what those employees are paid.
Our guide to payroll taxes delves deeper into the specifics of each type of payroll tax, but here’s a quick overview before we jump into manually calculating payroll.
- Federal income taxes are taxes employees pay on all taxable income.
- FICA taxes (Federal Insurance Contributions Act taxes) include both the employer and employee half of Medicare and Social Security taxes.
- FUTA taxes (Federal Unemployment Tax Act taxes) are taxes paid by employers only.
- SUTA taxes are state unemployment taxes paid by businesses and not employees in most states.
- Some states and local municipalities charge taxes as well, such as a state income tax.
SEE: When Are Payroll Taxes Due?
How to manually calculate payroll taxes
While employers can calculate payroll by hand using the IRS’s federal income tax withholding tables, a paycheck calculator, or a spreadsheet template, running payroll manually is time-consuming. It may also increase your risk of making inaccurate paycheck calculations, which can expose your business to lawsuits, IRS fines, and other penalties.
Our guide below is a general payroll tax overview, but we strongly recommend talking with your accountant, bookkeeper, tax professional, or other financial advisor before you run payroll for the first time.
Calculate gross pay
Before you can make necessary deductions from employee paychecks, you need to calculate the total amount of compensation each employee earned over the course of the pay period.
For hourly workers, this typically means multiplying hours worked by the rate of pay. Don’t forget to account for any overtime hours worked at a higher rate of pay, along with any commissions, tips, or bonuses.
For salaried workers, calculating gross pay usually means dividing an employee’s annual compensation by the number of pay periods in the year.
- If you pay employees weekly, divide by 52 for a typical year or 53 for a leap year.
- If you pay employees bi-weekly (every other week), divide by 26.
- If you pay employees semi-monthly (twice a month), divide by 24.
- If you pay employees once per month, divide by 12.
Calculate federal income tax withholding
The amount of money you withhold for federal income tax depends on each employee’s income, plus the information they provide you with on IRS Form W-4.
Employers are required to collect Form W-4 (also known as the employee’s withholding certificate) from all traditional employees when they’re hired. Employees may modify their W-4 withholding information throughout the year.
Your employees will fill out the following information on Form W-4:
- Step 1: Taxpayer information, including name, address, Social Security number, and tax-filing status (single, married filing jointly, head of household or married filing separately).
- Step 2: Additional sources of income, including self-employment income or income from a spouse’s job.
- Step 3: Tax credits based on dependents, if any.
- Step 4 (optional): Additional adjustments to income tax withholding amounts.
From there, you’ll turn to IRS Publication 15-T, which outlines the two main methods of making income tax withholding calculations: The wage bracket method and the percentage method.
Typically, you’ll use the wage bracket method found on page 12 to manually calculate tentative withholding amounts for workers making $100,000 or less per year. For employees who make more than $100,000, you’ll use the percentage method found on page 56.
Calculate FICA taxes
Unlike federal income taxes, which vary between employees, FICA taxes are charged at a flat rate, which makes them easier to calculate.
- The Social Security tax rate is 6.2%.
- The Medicare tax rate is 1.45%.
Manual calculation example
Manually calculating payroll taxes involves several steps, each requiring precision to ensure accuracy and compliance. Below, we walk through an example using a hypothetical employee with an annual salary of $100,000. We’ll cover federal income taxes, FICA, and state taxes using California as an example.
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Note: For simplicity, we don’t include pre-tax deductions, like health insurance premiums and retirement contributions, in our calculation. Pre-tax deductions are optional benefits you can offer employees to lower their taxable income. |
Step 1: Calculate gross pay
Calculate the employee’s gross pay based on their pay period. Let’s assume the employee is paid every other week (26 pay periods per year).
- Gross pay per pay period = annual salary / 26
- Gross pay per pay period = 100,000 / 26 = 3,846.15
The gross pay per pay period for this employee is $3,846.15.
Step 2: Calculate federal income tax withholding
Federal income tax withholding is based on IRS guidelines found in Publication 15-T. Employers use either the wage bracket method or the percentage method to determine withholding. We’ll demonstrate both.
Wage bracket method
We’re assuming the employee is single and claims no dependents. For every other week’s pay, the wage bracket table shows an employee earning $3,846.15 per pay period should have $533 withheld.
Percentage method
- Start with the employee’s gross pay: $3,846.15.
- Subtract the standard deduction per pay period for single filers: $208.64. So, this equation would be $3846.15 – $208.64 = $3637.51.
- Apply the percentage. For this example, the rate is 22% for income over $2,375.00. So, the equation would be $3637.51 – $2375.00 = $1262.51 X 0.22 = $277.75. Then, add that $277.75 to the standard deduction of $208.6 per pay period for single filers for a total of $486.39.
Step 3: Calculate FICA taxes
FICA taxes include Social Security and Medicare taxes. These are straightforward and based on fixed rates.
- Social Security tax: 6.2% of gross wages. $3846.15 X 0.062 = $238.46.
- Medicare tax: 1.45% of gross wages. $3846.15 X 0.0145 = $55.77.
The total FICA taxes are: $238.46 + $55.77 = $294.23.
Step 4: Calculate California taxes
For an income of $100,000 annually in California, this falls in the 9.3% tax bracket.
$3846.15 X 0.093 = $357.69
California also imposes a state disability insurance tax of 1.1%.
$3846.15 X 0.011 = $42.31
The total state tax deductions per pay period for this employee: $357.69 + $42.31 = $400.
Step 5: Calculate net pay
Now that we have all the deductions, we calculate the employee’s net pay by subtracting the taxes from the gross pay.
- Federal income tax (percentage method): $486.39.
- FICA taxes: $294.23.
- California state taxes: $400.00.
Net pay = $3846.15 – $486.39 – $294.23 – 400 = $2665.53.
This employee’s net pay per pay period would be $2,665.53. Keep in mind this calculation does not include any other deductions, like healthcare, retirement, or municipal tax deductions.
Step 6: Double-check calculations
It’s crucial to double-check each calculation to ensure accuracy. Even a small mistake — such as forgetting the additional Medicare tax for high earners or misapplying the state tax rate — can lead to compliance issues and penalties. Always cross-reference IRS and state tax tables, and consider using payroll software to automate these calculations and reduce the risk of errors.
Social Security taxes may only be charged on the first $160,200 of an employee’s annual wages. In contrast, there is no income cap for Medicare taxes, though individuals making more than $200,000 a year are subject to an additional Medicare tax of 0.9%.
Note that as an employer, you’re required to match your employees’ Social Security and Medicare taxes. Employers don’t need to match additional Medicare taxes for higher-paid workers.
Calculate state and local tax withholding
If the state where your employees work charges an income tax, you’ll need to complete a process similar to the one you followed to find tentative income tax withholding amounts. Each area has its own state-specific tax laws, so you’ll need to find your state’s regulations to calculate any state tax deductions.
Make other payroll deductions
If a portion of your employee’s wages go toward healthcare premiums, charities, retirement funds or other causes, make sure to deduct those before signing off on their paycheck.
Calculate net pay
Once you’ve calculated your employee’s gross pay and made all the appropriate deductions, you’re left with their net pay, or take-home amount. Most employees today receive their pay via direct deposit, though paper checks and prepaid debit cards remain popular alternatives.
Calculate FUTA and SUTA taxes
Employees don’t contribute to either FUTA or SUTA taxes, but the amount of money you as an employer contribute to each fund is based on the number of employees you have and how much they earn.
FUTA taxes are equivalent to 6% of the first $7,000 of an employee’s wages. However, if you also pay unemployment taxes on a state level, you might qualify for a 5.4% FUTA credit, which lowers your FUTA tax rate to 0.6%.
SUTA tax rates and wage bases vary from state to state, so you’ll need to look up your state’s specific tax laws to figure out whether you pay SUTA taxes and, if so, how much.
Common payroll tax mistakes and how to avoid them
Calculating payroll taxes can be complex, and even the most experienced payroll professionals can make mistakes. These errors not only affect your company’s compliance but can also result in costly penalties and legal issues.
1. Miscalculating overtime pay
One of the most frequent payroll mistakes is miscalculating overtime pay. A common way this error occurs is when employers use an employee’s base hourly rate to calculate overtime instead of factoring in additional earnings like commissions, bonuses, and shift differentials.
Avoid this mistake by:
- Ensuring your payroll system and policies are up to date with FLSA requirements and any state-specific overtime laws.
- Automating the process with payroll software that correctly calculates overtime based on all forms of compensation.
- Regularly auditing your payroll records to catch any miscalculations.
2. Incorrectly applying Social Security caps and Medicare tax rates
Social Security and Medicare taxes are straightforward, but the IRS imposes limits and additional requirements based on income levels. For instance, the Social Security tax applies only to the first $176,100 of an employee’s annual wages. Once an employee’s income exceeds this cap, no additional Social Security tax should be withheld. Employers sometimes fail to stop these deductions, leading to overpayment and administrative complications.
Avoid this mistake by:
- Setting alerts in your payroll system to notify you when an employee reaches the cap.
- Regularly reviewing IRS updates on wage caps and tax rates.
3. Failing to update state and local tax rates annually
State and local tax rates vary significantly and often change yearly. Employers may inadvertently apply outdated tax rates, resulting in incorrect deductions for employees. This issue is particularly prevalent in states with complex tax regulations or local municipalities that impose additional taxes.
Avoid this mistake by:
- Subscribing to email alerts from your state’s Department of Revenue or tax authority.
- Reviewing and updating your payroll system’s tax rate settings to align with the current state and local tax regulations.
- Performing an annual audit of your payroll processes to verify that state and local tax rates are being applied correctly.
Maintaining compliance with tax filing deadlines
Staying compliant with payroll tax filing deadlines is crucial for avoiding penalties and ensuring your business runs smoothly. Federal, state, and local authorities each have their own filing requirements, making it essential for employers to stay organized. Here are a few tips to help you stay organized.
- Set calendar reminders. One of the simplest ways to stay on track is by setting calendar reminders for all federal, state, and local tax deadlines. Your online calendar or project management system can ping you as due dates approach.
- Subscribe to IRS and state alerts. The IRS and many state tax agencies offer email alerts for tax law changes, filing updates, and deadline reminders. Subscribing to these services helps you receive timely information and updates directly from tax authorities.
- Perform routine reviews. Schedule periodic reviews of your payroll processes to ensure they align with the latest IRS and state requirements. Review IRS publications for federal guidance and consult your state’s Department of Revenue for state-specific updates.
Other options for calculating payroll taxes
While it’s helpful to know how payroll tax calculations work, it’s extremely challenging to do them correctly by hand. Fortunately, several other options can simplify tax calculations and filing:
- Payroll spreadsheet templates for programs like Excel or Google Sheets should come with pre-filled cell formulas that accurately calculate and record payroll taxes.
- Free paycheck calculators can help you pay hourly and salaried workers correctly in every state.
- Payroll software calculates paychecks and taxes, pays employees (usually through automatic direct deposit), syncs with accounting software, and gives employees legally required pay stub access.
- An in-house bookkeeper or virtual accounting company can run payroll and file taxes on your behalf.
- Outsourced PEO companies can handle both payroll and general HR services by becoming legal co-employers with your business.
Worried about cost? Most payroll software companies offer free trials between 30 days (SurePayroll by Paychex and OnPay) and three months (ADP). Our complete guide to payroll software can tell you more about how to find the right payroll program for your needs and budget.
Frequently asked questions
What is the employee payroll tax?
Employee payroll taxes include the federal income tax, which varies based on individual or household income (as well as other factors). Employees also pay FICA taxes (Social Security tax and Medicare tax) at a flat rate of 7.65%.
How do I manually calculate payroll taxes?
Manually calculating payroll taxes is a multi-step process:
- Calculate an employee’s gross pay.
- Deduct federal income taxes based on the employee’s Form W-4 and the IRS’s tax withholding tables.
- Deduct FICA taxes (Social Security and Medicare taxes) at a rate of 7.65%.
- Deduct any state or local taxes, which have variable rates dependent on your location.
While you can calculate payroll taxes by hand, we recommend using a more reliable, less time-consuming method. Payroll software can calculate payroll taxes for you, typically at a fairly affordable cost, and can reduce your risk of making costly payroll tax errors.
How much payroll tax is taken out of my paycheck?
The amount of payroll tax taken from your paycheck depends largely on your income. The main payroll tax deductions include federal income taxes (variable by person), Social Security taxes (6.2%) and Medicare taxes (1.45%). Depending on where you live and work, you might also be subject to a state income tax.
Which payroll taxes do employers have to pay?
Employer payroll taxes include the employer portion of Social Security taxes and Medicare taxes, which matches the employee’s contribution dollar for dollar. Employers also pay FUTA and SUTA taxes, or federal and state unemployment insurance taxes.
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