Level Up Your Business Today
Join the thousands of people like you already growing their businesses and knowledge with our team of experts. We deliver timely updates, interesting insights, and exclusive promos to your inbox.
Join For FreeHow To Calculate Payroll
Our guide takes the guesswork and stress out of learning how to calculate payroll and payroll taxes for your business without an accountant.
-
WRITTEN & RESEARCHED BY
Expert Contributor
Last updated onUpdated
-
REVIEWED BY
Managing Editor
Our content reflects the editorial opinions of our experts. While our site makes money through referral partnerships, we only partner with companies that meet our standards for quality, as outlined in our independent rating and scoring system.
Key Takeaways
- Payroll tax calculations are essential for business owners, even if they use payroll software, as it involves calculating gross pay, subtracting taxes, and handling deductions to determine net pay.
- Federal payroll taxes include Social Security and Medicare, which are shared between employers and employees, while state and local taxes vary, with additional state-specific payroll taxes like unemployment insurance.
The best payroll software automatically calculates payroll and payroll taxes, so most business owners never have to worry about manual calculations. However, learning how to calculate payroll is a useful skill for business owners, even if you never have to do so manually.
This guide breaks down everything you need to know about payroll calculations, from calculating payroll taxes to handling wage deductions. Let’s dive in.
Table of Contents
What Is The Formula For Calculating Payroll Taxes?
The formula for calculating payroll taxes is:
(Gross Income) X (Payroll Tax Rate) = Payroll Tax Liability
Each payroll tax rate percentage should be converted to a decimal. To do so, divide the rate by 100.
You’ll need to calculate each payroll tax individually and subtract each liability from your employee’s gross earnings.
What To Know Before Calculating Payroll
Before beginning the process of manually calculating payroll, you’ll need to determine your employees’ tax withholding, understand the difference between gross pay vs net pay and post-tax pay deductions, and figure out your state’s payroll taxes.
Keep reading for a breakdown of the most important things to know before calculating payroll, or jump ahead to the first step of calculating payroll.
How To Calculate Payroll in 8 Steps
To calculate payroll, you need to subtract payroll taxes and deductions from an employee’s gross pay.
The following step-by-step instructions will take you through the process of calculating payroll and managing payroll taxes for your small business.
Step 1: Calculate Your Employee’s Gross Pay
Gross pay is the total money earned by an employee before deductions and taxes are subtracted.
To calculate gross pay for an employee, you’ll have to add up an employee’s total wages, salary, commission, tips, year-end bonuses, and any other form of earnings.
Let’s break down how to calculate the various types of earnings that go into a W-2 employee’s gross pay for each paystub.
Step 2: Add Supplemental Earnings To Gross Pay
As gross pay includes both traditional wages and supplemental earnings, the next step in the payroll calculation is to add supplemental pay to your employee’s hourly and salaried earnings.
Supplemental earnings are any wages earned outside of hourly or salaried wages, including overtime, tips, commission, and more.
As supplemental earnings differ, you’ll have to do the math for each item individually before adding it to the existing gross pay earned during the current pay period according to your payroll schedule.
Here’s a look at how to calculate the most common supplemental earnings.
Step 3: Calculate Federal, State, & Local Income Tax
Income tax is just the first of the payroll taxes you’ll need to calculate.
Generally, you can calculate income tax by multiplying your employee’s gross earnings by the going tax rate. You’ll subtract federal, state, and local income tax liabilities from your employee’s gross pay.
(Gross Earnings) X (Income Tax Rate) = Income Tax Owed
You can use the same formula (not tax rates!) to calculate federal, state, and local income tax liabilities.
Step 4: Calculate Federal Payroll Taxes: Social Security, Medicare, & FUTA
To learn how to calculate federal payroll taxes, you’ll first need to know the federal payroll tax rates. Here’s a breakdown of federal payroll taxes and their rates:
- Social Security Tax: The combined Social Security tax rate is 12.4%, with employers responsible for paying 6.2% out of pocket and withholding the employee’s 6.2% share. Social Security taxes total 12.4% and may be levied up to the $147,000 taxable wage limit.
- Medicare Tax: The combined Medicare tax is 2.9%, with employers responsible for paying 1.45% out of pocket and withholding the employee’s 1.45% share. Medicare tax increases by 0.9% for individuals earning over $200,000 annually.
- Federal Unemployment Insurance Tax: The current FUTA tax rate is 6% on the first $7,000 in wages paid to an employee per tax year.
Subtract federal payroll tax liabilities from your employee’s gross pay.
Step 5: Subtract State Payroll Taxes From Gross Earnings
In addition to state-level income tax, states may also levy payroll taxes for employee benefits or state programs. The most common state-level payroll tax is state unemployment insurance (SUTA), which is taxed at a different rate depending on your state.
Other state payroll deductions may include contributions to state employee benefits plans. For example, some Massachusetts employees pay 0.0063% as a contribution to the state’s paid family leave program.
The IRS maintains a directory of state websites to help businesses find the most up-to-date state payroll tax rates.
Step 6: Subtract Pre-Tax Payroll Deductions
After you’ve covered income taxes, Social Security, and Medicare, there may be more deductions you’ll need to make from employees’ pre-tax gross pay. Deductions may be mandatory or voluntary. Here are some potential payroll deductions that may apply to your employee:
- 401(k) Contributions: Payments made toward a 401(k) or retirement fund are deducted because they aren’t taxable.
- Health Insurance: A deduction is made for the amount an employee contributes to their own health, dental, vision, or other medical insurance.
- Life Insurance: This voluntary deduction goes toward the employer’s cost of paying for coverage.
- Reimbursements: Payments for meals, mileage, per diem, lodging, etc., are nontaxable and should be deducted.
Step 7: Subtract Post-Tax Deductions & Wage Garnishments
Once you’ve deducted payroll taxes and pre-tax payroll deductions, you’ll need to subtract any applicable post-tax deductions from the employee’s remaining earnings.
Post-tax deductions include:
- Wage garnishments
- Roth IRA contributions
- Voluntary charity donations
- Employee benefits contributions
- Disability insurance
- Union dues
The amount of these post-tax deductions will vary depending on which ones apply to your employee.
Step 8: Calculate Net Pay
To calculate an employee’s net pay, subtract all tax withholdings, payroll deductions, and wage garnishments from the employee’s gross wages.
This is the amount paid that employees are paid through direct deposit or physical paycheck. Net pay will show up alongside gross pay on an employee’s pay stub.
Once you’ve finalized all your calculations, you can cut the checks.
Use Payroll Software To Simplify Payroll Calculations
Manually calculating payroll and payroll taxes can be time-consuming, and making costly mistakes is easy. Moreover, as your business grows, manually handling payroll becomes even more inefficient, especially when you consider the option to automate and streamline the payroll process with payroll software.
That being said, many small businesses choose to handle payroll manually as a means to save money on payroll costs. However, there are solid cheap payroll software options on the market that help you save on costs while still handling all basic payroll tax calculations for you.
In short, the right payroll software can save your business time and make running payroll easy, from your first FICA tax payment to calculating employee bonuses.
The Bottom Line On How To Calculate Payroll
As an employer, your payroll tax responsibilities are two-fold: you have to withhold the right amount of taxes from employee paychecks and pay your business’s payroll tax liabilities on time.
We recommend investing in a payroll software solution that can help you keep everything organized, automate payroll tax calculations and payments, and ensure that your employees are paid on time with the right amounts withheld.
Although payroll software is an investment, the benefits of payroll software can definitely outweigh any payroll software costs. Otherwise, you may consider an accountant to help manage your business’s payroll taxes.
Davina Ward
Expert Contributor
Davina began writing for small businesses in 2018 and has since gained expertise in the SaaS industry. She earned her Bachelor’s of Arts in English Literature from SUNY Geneseo in 2018. She currently resides in New York.
View Davina Ward's professional experience on LinkedIn.
Latest posts by Davina Ward (see all)
- Best Payment Processors For Online Donations - April 25, 2024
- Homebase Payroll Review - December 18, 2023
- OnPay Payroll Review - December 1, 2023
- Payroll Software Cost Guide - November 3, 2023
- How To Choose Payroll Software For Your Small Business - November 3, 2023
Our Experts Are Listening
Get in touch with a real human being on the Merchant Maverick team! Send us your questions, comments, reviews, or other feedback. We read every message and will respond if you'd like us to.
Reach Out Our Experts Are Listening
Get in touch with a real human being on the Merchant Maverick team! Send us your questions, comments, reviews, or other feedback. We read every message and will respond if you'd like us to.
Reach Out
We Want Your Feedback
Let us know how well the content on this page solved your problem today. All feedback, positive or negative, helps us to improve the way we help small businesses.
Give FeedbackRead Next
