How to Calculate Payroll Taxes in 5 Simple Steps
If you're a business owner that's committed to continuous learning, or if you're simply interested in strengthening your ability to manage your small business finances, this article is for you.
Entrepreneurship is a never-ending learning process. Whether it’s gaining resilience and overcoming failure or fine-tuning your leadership skills — there’s always room for improvement as a business owner.
Some of these lessons are more abstract than others. There are many ways to learn how to succeed in sales negotiations, for example, but there’s only one approach to calculating payroll taxes for small businesses.
The latter is a complicated task that’s a requirement for every business. While every business owner should have a fundamental understanding of how payroll taxes are calculated, Roll by ADP believes that it should just be that — an understanding, as opposed to a regular frustration. We know that your plate is full and you’re juggling hundreds of things at once to keep your business running, which is why we handle your payroll taxes for you from start to finish. While it’s important to understand the process, you shouldn’t be spending hours of your valuable time stressing over it. Our innovative platform will calculate, deduct, and pay your company’s taxes for you in minutes!
But if you’re a business owner that’s committed to continuous learning, or you’re simply curious about how payroll taxes work, this article is for you. Today we’ll be providing a complete and comprehensive overview of how to calculate payroll taxes.
Types of Payroll Taxes
Understanding the different types of small business payroll taxes is an essential part of learning to calculate them (because the answer to the question “What percentage does an employer pay in taxes?” varies depending on the type of tax you’re discussing).
Let’s take a closer look at each type of payroll tax:
The Federal Insurance Contributions Act (FICA) is a mandatory tax that’s automatically deducted by employers from each employee’s paycheck. The tax is used to cover the cost of Social Security and Medicare services. These contributions are matched by employers and totaled 15.4 % in 2022.
When an employee loses their job, they are entitled to unemployment compensation under the Federal Unemployment Tax Act. To fund these payments, businesses in the United States are required to deduct unemployment tax from each of their employees’ wages.
Federal and State Income Tax
Federal and state income taxes are required under American law. These tax contributions are used to fund government programs and services at each respective level (federal and state). Examples of federal expenses covered by income tax include highway maintenance, low-income housing initiatives, infrastructure, and military defense. Examples of state expenses include public education, transportation systems, prisons and correctional programs, and government administration.
Calculating Payroll Taxes for Employees
To calculate payroll taxes for employees, begin by determining gross pay and identifying taxable income. Deduct pre-tax contributions, apply federal, state, and local tax rates, and calculate FICA taxes. Subtract post-tax deductions and arrive at net pay. Keep thorough records for compliance and auditing. This ensures accurate withholding and contribution calculations in adherence to tax regulations.
If you choose not to use Roll’s fast and easy platform, here are the steps you’ll need to follow:
Step One: Collect All Necessary Employee Documents
There are a number of documents your employees will need to fill out and submit prior to you preparing your payroll taxes. These documents include:
Form I-9 (Employment Eligibility Verification)
Form I-9 is provided and processed by the United States Citizenship and Immigration Services. Its purpose is to verify the identity of an employee and whether or not they are legally sanctioned to work in America.
Form W-4 (Employee’s Withholding Certificate)
Administered by the Internal Revenue Service (IRS), a W-4 is used to confirm how much money an employer can legally withhold from an employee's paycheck for tax purposes. There are several factors that impact how much of an employee’s wages can be withheld, including whether or not the person is married, the number of dependent children they have, and whether or not they give permission for additional allowances to be taken.
Direct Deposit Authorization Form
Direct deposit forms are used to permit employers to issue electronic payments that are automatically accepted into an employee's bank account. Providing this form allows employees to receive payments safely and quickly. For this reason, it’s considered standard best practice for employers to use direct deposit for all payroll-related transactions.
State W-4 (For Applicable States)
When learning how to figure payroll taxes, it’s important to remember that certain states require a separate W-4 form (in addition to a federal W-4). To determine which withholding forms apply to your business, visit your state government website.
Step Two: Determine the Number of Hours Worked
In order to accurately calculate payroll taxes, you’ll need to know exactly how many hours your employees worked (or, if they’re a salaried employee, you’ll need to know how much they earn per pay period). This will be much easier if you use a dedicated program to track hours, but if not, we recommend converting times to decimal values for easier calculation.
For example: If an employee worked 37 hours and 15 minutes in a week, the decimal figure would be 37.25 hours.
Step Three: Calculate Gross Pay
Once you know the number of hours an employee worked given a particular pay period, you’ll need to multiply their hourly rate by that number.
For example: Let’s say the employee’s hourly rate is $20.00. If they worked 37.25 hours, the calculation would be: 20 x 37.25 = gross pay. So, in this instance, the gross pay amount would be $745.00.
It’s important to note that if an employee has worked overtime, you’ll need to calculate these hours separately, since the hourly rate will be different.
Here’s an example of how to calculate regular and overtime hours:
The employee worked 40 hours at their usual hourly rate of $20.00. They also worked six hours of overtime at $30.00 per hour.
You start by calculating the regular hourly rate (20 x 40) which equals $800.00. Then you calculate the overtime rate (30 x 6) which equals $180.00. Now add both numbers together (800 + 180) and you get the employee’s gross pay, which is $980.00.
Step Four: Subtract Applicable Payroll Deductions
The next step in learning how to calculate payroll taxes for employees is detracting mandatory and voluntary deductions from the employee’s gross pay. To do this, you’ll need to calculate the amount of each deduction and then subtract it from the gross pay amount.
Here’s how to calculate the required amount for each type of deduction:
As of 2023, the FICA tax rate is 15.3% of an employee’s gross pay. But remember, employees only pay half that amount for a deduction of 7.65%.
For example: Let’s say an employee’s gross pay for a 2-week period is $1,500.00. To determine their FICA deduction, you would multiply the gross pay amount by 7.65% (1,500 x 7.65%) which equals $114.75.
The Federal Unemployment Tax Act (FUTA) stipulates that employers must deduct 6% of an employee's gross income. It’s important to note, however, that the tax only applies to the first $7,000 an employee makes during a calendar year.
For example: Your employee earns $60,000 annually. Their unemployment tax would only apply to the first $7,000. Thus, to calculate the amount, you would multiply 7,000 by the tax rate (7,000 x 6%) and your answer would be $420.00.
Where unemployment tax gets a little tricky is when you have to calculate the total amount of unemployment tax deducted for all of your employees. Since employers can claim a credit for unemployment tax, you’ll need to know exactly how much you contributed on behalf of your workers.
For example: If you have eight employees who earn $50,000 per year. This means you must apply the unemployment tax on the first $7,000 for all eight employees. To do this, you would multiply 7,000 by the tax rate a total of eight times (7,000 x 6% x 8), which equals $3,360.00.
FEDERAL INCOME TAX
Unlike the other forms of tax listed above, federal income tax rates vary depending on the amount an employee makes per year (known as their taxable income bracket). These tax brackets can change over time so it’s always best to do your research, but we’ve included a chart below for 2023.
$0 to $10,275
$10,276 to $41,775
$41,776 to $89,075
$89,076 to $170,050
$170,051 to $215,950
$215,951 to $539,900
$539,901 or more
Using the chart above, let’s say your employee makes $90,000 per year. This means their tax rate is 24%, right?
Well, not quite. The tax rate only applies to the amount the person earned within that specific bracket. Which means the employee would pay 10% on the first $10,275 they earned, 12% on the amount up to $41,775, 22% on the amount up to $89,076, and then 24% on the remaining amount.
Because this can get a little confusing, most people calculate their effective tax rate (the average rate when all tax brackets are applied). To find it, simply take the total amount of federal income tax that’s been deducted from all of an employee's paychecks and divide it by the employee's total taxable income. The percentage you get is your employees effective tax rate.
STATE INCOME TAX
Unlike federal income tax, which follows the same bracket system for all American citizens, state income tax rates vary from state to state. You’ll need to familiarize yourself with your state tax rate to make accurate estimates.
For example: Arizona has two tax brackets: 2.55% on income up to $28,653 and 2.98% on income up over $28,653. If you have an employee that makes $80,000 per year, they’d pay 2.55% on the first $28,653 which equals $730. They’d then pay 2.98% on the remaining $51,347, which equals $1,530. When we do the match, $730 + $1,530 = $2,260.00 in state income taxes.
Many employees have the option of contributing to a 401K plan via their employer. If you offer such a plan, you’ll need to deduct these contributions from your employee’s paychecks, and since each plan is different, you’ll need to know exactly how much your employee contributes.
For example: Let’s say your employee earns $90,000 per year and contributes 6% of their annual salary to their 401K plan. This means they pay $5,400 per year (90,000 x 6%). If you operate on a 2-week time period, that means you’ll need to deduct $207.70 from each paycheck ($5400 / 26 pay periods).
If an employee has been court-ordered to repay a debt, such as unpaid student loans or outstanding child support payments, the government may require an employer to deduct a percentage of a worker’s paycheck to be applied to their deficit. In America, the maximum amount an employer can garnish from a single employee (without any dependents) is 60% of their total wages and 50% if the employee is married or has children to support.
Step Five: Calculate Net Pay (AKA Take-Home Pay)
After you’ve subtracted all applicable deductions, you’re ready for your last lesson in how to calculate payroll taxes — determining the final amount your employee will earn now that their voluntary and mandatory deductions have been made. While you can always use a handy paycheck calculator, it’s important to be familiar with manual calculation as well. To do this, you’ll simply need to subtract the total amount of their combined deductions from their gross pay.
For example: If an employee has a gross annual income of $50,000 and his deductions were a total of $12,250, his net pay would be $37,750.00.
Now you no longer have to wonder “How much does an employer pay in payroll taxes?”. We’ve covered all of the possible deductions employers are responsible for and you can always refer back to this page should you need a refresh in the future.
All that’s left to consider is “Where do payroll taxes go?” and that’s a question we’re also happy to answer. Payroll taxes are paid via the Electronic Federal Tax Payment System (EFTPS) or through your state government website. Once you have completed your calculations, you’ll just need to log into the appropriate account to finalize your submission.
Payroll in Under One Minute
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Our intuitive payroll app for small businesses automatically calculates, withholds, and files federal, state, and local taxes as necessary — for every type of employee, saving you precious hours and eliminating headaches.
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