Figuring payroll taxes isn’t difficult, but it can be complicated because there are a minimum of seven different federal taxes to consider — and even more when you factor in state and local income taxes. You may never need to manually calculate payroll taxes, but it's wise to know how to understand the process more thoroughly; this helps business owners spot errors and better control labor costs.
Add up the employee’s gross wages. Gross wages consist of hourly earnings or salary for the pay period plus any tips, commissions or other earned compensation. Don’t include reimbursements for business expenses. If those are to be included on a paycheck, they should be added after all taxes are calculated.
Determine federal taxable income. To do this, start by multiplying the number of withholding allowances (from the employee’s W-4 form) by the amount of one allowance for the length of the pay period (from the current year’s IRS Publication 15, Circular E). Subtract this amount from the gross wages. Subtract any other deductible amounts, such as contributions to a tax-deferred retirement plan. This is the federal taxable income.
Calculate federal income tax. Federal income tax is computed on a sliding scale using the tax tables in IRS Publication 15, Circular E. For example, suppose the federal taxable income for an employee who is single and paid biweekly works out to $500. There is no tax on the first $81 (2011 tax rates). From $81 to $408 the tax rate is 10 percent ($32.70). The amount over $408 ($92 in this example) is taxed at 15 percent ($13.80). Add the amounts $32.70 and $13.80 together to find the federal income tax to be withheld ($46.50).
Compute Social Security and Medicare taxes. The employee's portion of Social Security tax for 2011 is 4.2 percent of his gross income, unless the year-to-date earnings are more than the annual cap ($106,800 in 2011). Medicare tax is 1.45 percent of gross income with no cap. The employer pays 6.2 percent in Social Security and 1.45 percent in Medicare taxes.
Calculate any state and local income taxes. The formulas for state or local taxes (if any) vary. Contact your state, county or city department of taxation or revenue to obtain any required forms and the instructions on how to calculate these taxes.
Calculate federal unemployment (FUTA) and state unemployment (SUTA taxes). Always calculate the SUTA tax first, because you can take a credit for it against the FUTA tax. In most states SUTA is a flat percentage of employee pay up to a year-to-date earnings cap. In 2011, the FUTA tax is 6.2 percent on earnings accrued on or before June 30, and 6.0 percent on earnings accrued on or after July 1. This tax applies to the first $7,000 of earnings. However, you may subtract SUTA contributions up to 5.4 percent of employee earnings, leaving a minimum FUTA tax of 0.8 percent (or 0.6 percent on or after July 1, 2011).
Subtract those taxes the employee pays from the gross wages. Employee-paid taxes are the federal income tax, employee Social Security and Medicare and any state/local income taxes. All other items are employer-paid taxes and may not be deducted from an employee’s pay. Be sure to also deduct any contributions to retirement plans, health insurance or other items before making out the employee’s paycheck, and record the amount of each tax or other deduction in the appropriate place on the pay stub.
Based in Atlanta, Georgia, William Adkins has been writing professionally since 2008. He writes about small business, finance and economics issues for publishers like Chron Small Business and Bizfluent.com. Adkins holds master's degrees in history of business and labor and in sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.