Accounting & Finance
How To Calculate Payroll Tax For Your Employees
Once you hire employees, you become responsible for their payroll tax. Despite its label, a payroll tax isn’t a single type of tax. It’s a collective term that refers to government-mandated taxes deducted from your employees’ salaries.
Working With Employees
If you’re working with even a single employee, you’ll be responsible for the following:
- Paying your employees’ payroll taxes from the revenue of your business
- Deducting a portion from the salary of your employees to pay their taxes
You’re not alone if you’re having a hard time learning how to calculate payroll taxes. Millions of small business owners are experiencing the same dilemma. If that’s the case, you may consider using business calculators, or better yet, continue reading this article to find out how to calculate payroll taxes easily.
Before you start computing payroll taxes, you have to ensure that all employees have already completed the following forms, such as:
- Form I-9: Employment Eligibility Verification
- Form W-4: Employee’s Withholding Certificate
- Direct Deposit Authorization Form
- State W-4
Computing Employee Payroll Taxes
Once you have all these prepared (and your business as well), you can now compute your employees’ payroll taxes.
Here are the following steps you may execute to calculate payroll taxes effectively.
Step 1: Determine The Gross Pay Of Every Employee
Gross earnings are the amount employees may receive before withholding taxes. Calculating gross earnings depends on how you pay your employees, hourly or annually.
For hour-based employees, simply multiply the hours of work rendered and the hourly rate. For example, if your staff has a rate of USD$35 per hour and renders eight hours a day, their gross pay per week would be 40 (hours) × USD$35 = USD1,400.
Also, don’t forget to include their overtime pay, which is 1.5 times higher than the normal rate for every hour that exceeds their basic work schedule. For example, an hourly rate of USD$35 has an overtime pay rate of USD$52.50 per hour.
For annual-salary-based employees, gross pay will be based on the agreed annual salary, and it’ll remain fixed every period (every year). For example, if your staff receives USD$60,000 per year, their gross pay every two weeks (bi-monthly pay period) would be USD$60,000 ÷ 12 months ÷ 2 or USD$2,500.
In addition, gross wages include commissions, bonuses, and other monetary incentives an employee may receive based on their performance.
Step 2: Calculate Employee Tax Withholdings
Once you have identified your employees’ gross wages, you can now determine the amount you need to deduct to pay their taxes. In most states, employers should withhold different tax forms, including federal, state, and FICA taxes, from every paycheck.
Calculating Federal Income Tax (FTI) (2020 or later)
Using the employee’s Form W-4, you may now compute their FTI using the wage bracket method. Visit the IRS Publication 15-T and find the worksheet for the wage bracket method for FTI 2020 or later.
Once you see the worksheet, it’s time to proceed with the following steps.
Enter the employee’s total taxable wages (gross pay) on line 1a. Remember, gross pay includes commissions and other incentives an employee may receive.
In line 1b, input the number of employee pay periods yearly. Use Table 5 on the upper part of the same page.
In line 1c, input the income amount stated on the employee’s Form W-4 Step 4a. Then, divide it based on the number of pay periods (check line 1b) and input the amount on line 1d.
To fill up line 1e, combine the amount stated on lines 1a and 1d. This is the total amount an employee may receive before tax deductions.
In line 1f, input the number of deductions based on the employee’s Form W-4 Step 4b. Then, divide it based on the number of pay periods (check line 1b) and input the amount on line 1g.
In line 1h, calculate the employee’s Adjusted Wage Amount by subtracting lines 1g and 1e. If it’s zero, then enter 0.
To determine the 2a or the Tentative Withholding Amount, use the value stated on line 1h and compare it to the Wage Bracket Method found on the IRS Publication 15-T pdf.
Check the employee’s Form W-4 Step 3 and use the value to fill up lines 3a to 3c. This only applies if the employee has applicable tax credits.
In line 4a, input the amount stated on the employee’s Form W-4 Step 4c. Then, add the value to line 3c to get line 4b.
Now, you’re done computing for their FTI. You may proceed to other taxes.
Calculating Federal Insurance Contributions Act (FICA) Taxes
FICA includes Social Security and Medicare contributions. Here’s how you can compute them:
Social Security Contributions
Multiply employees’ gross wages by the current Social Security contribution rate of 6.2%. The other 6.2% will be paid by you, the employer. For example, an employee earning USD$6,000 will have a Social Security tax deduction of USD$372 (6000 × 0.062).
Multiply employees’ gross wages by the current Medicare rate of 1.45%. The other 1.45% will be paid by you, the employer. For example, an employee earning USD$6,000 will have a Medicare tax contribution of USD$87 (6000 × 0.0145).
State And Local Taxes
Some states may require additional income tax deductions, like Kentucky, Michigan, and others, while some may not, such as Florida, Texas, Washington, etc. The best thing to do is check the taxation laws in your local area to determine if you need to deduct more from your employees.
Step 3: Add Reimbursements
Ensure all employees who use their money to execute business operations are reimbursed. You may reimburse them in two ways: giving them the money personally (separate from payroll) or combining the reimbursements with employees’ payroll.
Remember that reimbursements aren’t to be included in your employees’ gross wages and shouldn’t be a part of any tax deductions.
Step 4: Sum It Up
Now that you’ve calculated your employees’ gross wages, FTI, Social Security, Medicare, state and local taxes, and reimbursements, it’s to sum it up and compute their paycheck (net pay). Here’s the process to do that:
- Determine employee’s gross pay
- Deduct tax deductions from FTI to state and local taxes
- Add reimbursements, if there are any
- Then, you get the net pay or the pay they can receive
Calculating payroll taxes can be overwhelming, but it doesn’t have to be. By knowing the right steps, you’ll be able to determine your employees’ tax deductions without a fuss. That being said, carefully check out the following steps above and follow them thoroughly to avoid mistakes.
Just a few reminders: don’t forget to check your local areas for additional income tax deductions and never include reimbursements to gross pay and tax deductions.