How to Calculate Payroll Taxes: A Step-by-Step Guide

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.

However, whether you’d 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 on their own that relate to how many 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 (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? (TechRepublic)

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%.

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.

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 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% for the 2023 tax year.

How do I manually calculate payroll taxes?

Manually calculating payroll taxes is a multi-step process:

  1. Calculate an employee’s gross pay.
  2. Deduct federal income taxes based on the employee’s Form W-4 and the IRS’s tax withholding tables.
  3. Deduct FICA taxes (Social Security and Medicare taxes) at a rate of 7.65%.
  4. 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.

Read next: How to Do Payroll: A Step-by-Step Guide (TechRepublic)

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