Calculate Payroll Taxes

Payroll tax calculations have a huge impact on both the employer and the worker. These calculations impact the total wage expense incurred by the employer. The tax calculations also affect the worker’s taxable income, personal tax liability, and net take-home pay. Payroll taxes are made up of federal and state tax withholdings, Social Security taxes, and Medicare taxes. It’s critical that the employer and the worker understand how payroll taxes and withholdings are calculated.

Steps

Calculating Federal Income Tax Withholding

  1. Have each worker complete a W-4. The top portion of the W-4 form includes a personal allowance worksheet. As an employee, you enter information about yourself and your spouse, if applicable. If you have children, you may also enter withholding information for each child.[1]
    • Assume that you and your spouse both work, and that you have three children who live at home with you.
    • On line A, you would enter 1 for yourself. Since your spouse works, line B would be 0.
    • On line C of the W-4, enter 3 (one for each of your dependent children). On line H, you add up the total allowances and enter 4. Your allowance total is entered on line 4 of the W-4 form.
  2. Apply the IRS rules to compute federal tax withholdings from gross pay. The worker provides the employer their filing status and the number of allowances they are qualified to take. The allowances are used to calculate the amount held from gross pay.[2]
    • Determine the employee's gross pay. Verify the employee’s total pay for the pay period. Gross pay includes any hourly wages, tips, and bonus compensation.
    • Locate the employee's filing status. This can be found on the employee's W-4 form. The status may be married, single or some other status listed on the form.
    • Find the number of allowances. Allowance are located on the employee's W-4. Allowances are claimed by the employee, and determine how much is withheld from the employee's pay to cover their income taxes. More allowances mean that less money is withheld for taxes.
  3. Go to the IRS withholding calculator. Enter the requested information to compute the correct withholding amount. The calculator asks for the worker’s tax filing status, and the number of dependents the individual is claiming. The app also requires your gross wages and how often you are paid (weekly, bi-weekly, monthly, etc.)[3]
    • The app requires total federal withholding payments year-to-date. The system will estimate your required withholdings for the year and subtract your year-to-date withholdings.
    • Assume a single employee has filed three allowances and is paid $1,000 weekly. Based on the allowance rules, assume that one allowance is $76.90. The three allowances would total ($76.90 multiplied by 3 allowances = $230.70).
    • Next, subtract the withholding allowances from the gross pay to determine the amount of pay subject to withholding. In this example, the employee's pay that is subject to tax withholding is ($1,000 - $230.70 = $769.30).
    • Refer to IRS Publication 15 to determine how much to withhold. Now that you know how much pay is subject to withholding for federal taxes, you can refer to the official IRS tables to determine how much to withhold. Make sure to look at the table that relates to the employee's filing status as well as their pay period. In this case, the filing status is single and the pay period is weekly.

Adding Up Deductions and Withholding

  1. Determine Social Security withholding. Social Security is a federal program that provides retirement income and disability income. The program is funded through tax withholdings.[4]
    • In 2017, Social Security withholding is 6.2% of the employee's gross pay.
    • The employee must pay this until they reach the wage base limit. Earnings above the wage base limit are generally not subject to social security tax.
    • The wage base limit for 2017 is $127,200.
  2. Figure out the Medicare withholding. Medicare provides medical coverage to both the elderly and disabled. This program is also funded through payroll tax withholdings.[5]
    • In 2017, Medicare withholding is 1.45% of the employee's gross pay.
    • There is no wage base limit for the Medicare withholding. This means that each dollar of gross pay is assessed the Medicare withholdings tax.
    • Single employees making over $200,000 a year have an additional 0.9% Medicare tax for every pay period after $200,000 in wages have been paid. The dollar threshold is $250,000 more married couples filing jointly. This includes all pay for a calendar year.
  3. Consider other deductions that reduce gross pay. Your employer may offer benefits that are funded through payroll deductions. Some of these deductions are made on a pre-tax basis. That means that the dollars deducted have not yet been taxed. The pre-tax deductions reduce the amount of pay that is subject to tax.[6]
    • Contributions to certain types of retirement plans can be made on a pre-tax basis. The most common plan is a 401(k) plan. A 401(k) plan is a retirement plan available in many for-profit companies.
    • People who work for non-for-profits or government agencies may participate in a 403(b) plan.
    • In both cases, the worker is contributing a larger amount into their retirement plan. Say, for example, that the worker wants to contribute $100. The contribution will be $100 before taxes, but less than that on an after-tax basis (maybe $80).
    • Since the employee contributes more at the beginning, they will accumulate a larger retirement balance. The taxation on these plans occurs when dollars are taken out at retirement.
    • A health flexible spending arrangement (FSA) is another benefit that may affect your gross pay. An FSA is a voluntary arrangement with your employer that allows you to be reimbursed for medical expenses. This account is funded by payroll deductions, though your employer may also contribute.[7] Any contributions from your employer do not have to be added to your gross income. The funds in this account do not roll over if not used within the year.
    • A health savings account (HSA) is similar to an FSA, though the money in this account does roll over from year to year, allowing you to accumulate savings specifically set aside for health care. An HSA remains with you if you change employers or leave the workforce.[8]

Figuring Out State and Federal Unemployment Taxes

  1. Keep in mind that unemployment tax is paid for by employers. In most states, just the employer pays the unemployment tax. This system, however, combines a federal unemployment tax system with a state program.[9]
    • Pay your state unemployment tax first. Your company can take a credit on your federal unemployment tax if you've already paid the state unemployment tax.
    • The 2017 federal unemployment tax is 6% of the first $7,000 you pay in wages to an employee.
    • If you've paid state unemployment taxes, you can take a credit of up to 5.4% on the federal calculation. If you take the full credit, the federal tax would decline to 0.6% of the first $7,000 in wages paid.
  2. Find the state guidelines for each of your employees. Each state has different tax rules, so you'll need to find the proper tax information for your employees. If you have employees in multiple states, each one is governed by a separate set of state tax laws.[10]
    • You can find the tax information through the state's Department of Revenue or Taxation.
    • Calculating state tax is very similar to calculating the federal tax. The tax rates, however, are different.
    • Be aware that not all states count the same wages as federal when calculating state tax. Make sure that you check the state rules when you’re processing taxes.
  3. Report and pay your tax withholdings. Each type of payroll tax uses a different tax form. You also will pay each type of tax through a different system. Consider hiring a payroll company to help you stay on top of this process.[11]
    • Accounting software is available to help you with these calculations. If you use software, make sure that the company sends you any necessary updates. As the tax law changes, the payroll tax software must be changed.
    • Most of the taxing authorities allow you to pay taxes electronically. Many of the required tax forms can be completed online.
    • A payroll company can take your employee data and make the necessary payroll calculations. They can also set up a system to pay each worker electronically. The payroll company will update their software for changes in the tax code.

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Sources and Citations

  1. ↑ https://www.irs.gov/pub/irs-pdf/fw4.pdf
  2. ↑ https://www.irs.gov/publications/p17/ch04.html
  3. ↑ https://apps.irs.gov/app/withholdingcalculator/
  4. ↑ http://www.ssa.gov/planners/taxwithold.html
  5. ↑ https://www.irs.gov/taxtopics/tc751.html
  6. ↑ https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Contributions
  7. ↑ https://www.irs.gov/publications/p969/ar02.html#en_US_2015_publink1000204174
  8. ↑ https://www.irs.gov/publications/p969/ar02.html#en_US_2015_publink1000204020
  9. ↑ https://www.irs.gov/Individuals/International-Taxpayers/Federal-Unemployment-Tax
  10. ↑ http://payroll.intuit.com/support/kb/1000105.html
  11. ↑ http://www.adp.com/tools-and-resources/compliance-connection/state-taxes/2015-fast-wage-and-tax-facts.aspx
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