How to Calculate Payroll

Calculating payroll does not have to be complicated. In fact, it can be broken down into just a few steps. These include:

  • Collecting your employees' information and IRS forms
  • Calculating your employees' gross income
  • Calculating the amount of FICA and other payroll taxes that you will need to withhold from your employees' salaries
  • Factoring in pre and post-tax deductions to determine your employees’ net income
  • Complying with the post-payment regulations of the IRS

In this guide, we provide a step-by-step review of how to calculate payroll for small businesses.

Calculate Payroll for Your Business

Before you can calculate payroll effectively, you will need to obtain a few forms from your employees. These will provide crucial information about your workers’ filing status and personal information, which you will need to determine how much should be withheld from their gross annual income. 

These forms include:

  • IRS and State Form W-4s: Form W-4s are categorized as “withholding certificates” by the IRS because they detail workers’ filing statuses. These dictate the total amount that is to be withheld by you as an employer for payroll taxes (e.g., FICA taxes, federal income tax, etc.).
  • Form I-9: This proves that your workers have the legal right to seek employment and work within the US. You should make sure that you receive a Form I-9 from every new employee that you hire.
  • Direct Deposit Authorization Form: Even though this is not a requirement in order to calculate payroll, you will need it if you want to pay your employees via direct deposit. 

You will then need to know how to make the following calculations:

  • Gross annual income
  • Withholding taxes
  • Net Income

Calculating Gross Annual Income

An employee’s gross annual income is the total income that they are entitled to before any deductions are made in their pay. Such deductions include:

  • Payroll taxes
  • Local, state, and federal income tax
  • Pre-tax deductions (e.g., 401(k) retirement plans, disability support, etc.) 
  • Post-tax deductions (e.g., garnishments, charitable donations, union dues, etc.)

For example, if an employee earns $2,000 per week, their gross annual income would be $2,000 x 52 (i.e., the number of weeks in a year), which would equate to $104,000 per annum. But, of course, this is not what they would actually receive from you as an employer. Instead, your employees will receive a net income.

Calculating Withholding Taxes

You will need to estimate the percentage of your employees’ salaries that is to be withheld for payroll taxes. This will depend on individuals’ filing status, total gross income, and other factors (e.g., number of dependents, number of allowances, etc.).

For the most part, all the information you need should be included in your employees’ W-4 forms. You may also choose to use the IRS Tax Withholding Estimator to perform “checkups” and ensure that you have withheld the right amount of money from your employees’ paychecks. 

Generally, the taxes you will need to withhold as an employer include:

Social Security Tax

As of 2021, the rate for Social Security tax is 6.2%. Employers are required to contribute an equivalent amount (6.2%) individually, meaning the total amount withheld for Social Security tax is 12.4% of an employee’s salary. 

Keep in mind that this is only applicable for the first $147,000 of an employee’s salary. 

Medicare Tax

Every employer is required to withhold 1.45% of an employee’s salary for Medicare tax. Furthermore, they must contribute an additional 1.45% independently.

Unlike Social Security tax, Medicare tax is applicable regardless of how much gross annual income a person earns. 

Additional Medicare Tax

The Additional Medicare Tax only needs to be withheld from your employees’ salaries after they have received over $200,000 per annum. Having said that, the minimum income threshold for the Additional Medicare Tax can vary significantly depending on persons’ filing statuses. 

For example, individuals who are married and filing jointly will only owe the Additional Medicare Tax after they have jointly earned $250,000 per annum, whereas married individuals filing separately have a much lower income threshold of $125,000. 

Note: You are required to begin withholding Additional Medicare tax from your employees as soon as they have received more than $200,000, even if their minimum income threshold is higher. Your employees will then be able to claim back the amount that is owed to them. 

Local, State, and Federal Income Taxes

For the most part, income taxes will depend on your location. Some states, including Alaska, Florida, Nevada, and Texas, have no state income tax. Others, such as California and Hawaii, have high state income tax rates that exceed 10%. 

Either way, you will need to factor local and state income taxes into your calculations and withhold these from your employees’ incomes in addition to the applicable federal income tax rate. 

The federal income tax rate will depend on your employees’ annual gross income:

  • $0 to $9,950: 10% tax
  • $9,951 to $40,525: 12%
  • $40,526 to $86,375: 22%
  • $86,376 to $164,925: 24%
  • $164,926 to $209,425: 32%
  • $209,426 to $523,600: 35%
  • $523,601 or more: 37%

State Unemployment and FUTA taxes

Unlike FICA and income taxes, state unemployment and FUTA taxes are not “withheld” from your employees’ salaries. Instead, they are made up by you as an employer. 

FUTA taxes are only applicable for the first $7,000 of your employees’ salaries. The FUTA tax rate is currently 6.0%; however, keep in mind that this can be reduced by up to 5.4% (to 0.6%) if state unemployment taxes are paid in full.

Calculating Net Income

Finally, you will need to make a few final deductions in order to determine your employees’ net income. This is the income that they actually receive.

You will need to subtract:

  • Wage garnishments: These can occur if an employee faults on a loan, needs to pay back taxes, or owes money to a third party as a result of a legal settlement. 
  • Other post-tax deductions: These include union dues, charitable donations, etc.

The final number is your employees’ net pay, and it is what they will expect to receive from you during every pay period. This may be on a weekly, biweekly, or monthly basis. 

As an employer, you retain full discretion over how often you pay your employees as long as you satisfy your state’s minimum payday obligations. These can be found on the US Department of Labor website.

Payroll Obligations for Employers

After you have correctly calculated the amount of taxes that you will withhold from your employees’ salaries and have finalized the amount that you will distribute to them on each pay period, you will need to follow a few additional steps in order to stay compliant with the IRS. 

These relate to how you deposit and report your payroll taxes.

Depositing Payroll Taxes

You will need to determine your payment schedule. This can be on a biweekly or monthly basis and will depend on the type of form that you will be using. 

For Form 941 and Form 944, see Publication 15 on the IRS website. For Form 943, see Publication 51

Keep in mind that all payments must be made online through the Electronic Federal Tax Payment System (EFTPS).

Reporting Payroll Taxes

When submitting your payroll taxes, you will need to use a different form depending on the type of payroll tax in question. For example:

Specific circumstances may demand the use of additional forms:

  • Backup withholding (Form 945)
  • Workers working in agriculture (Form 943)
  • Employers who have been notified about the Form 944 program (Form 944)

Withheld payroll taxes can be reported online or by mail. The IRS recommends that individuals rely on the former option through E-File; however, persons are entirely free to report these by mail if they wish to.

If you want to file by mail, the address that you will need to report these to will depend on your state and the type of form you are using. More information on where to submit forms can be found on the IRS website:

Filing Your Form W-2s and W-3s

Any business that pays $600 or more in payroll taxes is legally required to file both a Form W-2 and a Form W-3 with the Social Security Administration (SSA). This needs to be done for every person that is employed.

Individuals wishing to submit these by mail are required to order scannable copies from the IRS to avoid fines. This can be done by calling 1-800-829-3676 or by visiting the IRS website.

When filling in your forms, keep the following IRS guidelines in mind:

  • Leave all non-applicable boxes empty: Do not fill them in with “NA” or any other abbreviation.
  • Do not use dollar signs or commas
  • Use blank ink when typing in your entries
  • Use a new form if you make any traceable mistakes

Note: If you employ 250 or more individuals, you are required to file your form W-2s electronically unless otherwise specified by the IRS.

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Frequently Asked Questions

When does certified payroll need to be submitted?

Certified payroll is a weekly payroll report that is submitted through Form WH-347. This needs to be submitted by employers when they are working on projects which:

  • Are federally funded (fully or partially)
  • Have a value that exceeds $2,000

For more information on certified payroll, see our What Is Certified Payroll guide.

Should I handle payroll by myself?

You can handle your business’s payroll entirely by yourself, but this is typically not recommended because it’s time-consuming and may carry hefty fines and back taxes if done incorrectly. 

Other options for handling payroll include:

  • Hiring a tax attorney
  • Working with an accountant
  • Using a professional payroll service

For a more in-depth look, see our guide on how to do payroll yourself.

How many payroll taxes are there?

Employers are required to withhold the following taxes from employees’ salaries:

  • Social Security tax
  • Medicare tax and the Additional Medicare Tax
  • Local, state, and federal income taxes
  • State unemployment and FUTA taxes: The burden of this is carried exclusively by employers

Do I need an EIN to do payroll?

es, an EIN is basically the “Social Security” number of your business, meaning it is used by the IRS to identify businesses and is necessary for any business that wants to hire employees.

If you do not currently have an EIN, you can apply for one by either:

  • Applying online via the IRS website
  • Faxing a completed Form SS-4 to (855) 641-6935
  • Mailing the completed form to the following address:
    • Internal Revenue Service
      Attn: EIN Operation
      Cincinnati, OH 45999
  • Calling (267) 941-1099 (This is only available for international entities.)

See our What is an EIN guide for further instructions.

What information should I include on business paychecks?

Any paycheck distributed to your employees should include:

  • A check number
  • Your name and address 
  • The name and address of the individual receiving the check
  • The date that the paycheck is being issued
  • The total payment amount
  • Your business bank account

Do I need to withhold FUTA taxes after $7,000 per annum?

No. FUTA taxes are only applicable for the first $7,000 that an employee makes per year. 

This means that the FUTA tax rate of 6.0% should not be applied to any taxable income after this threshold has been exceeded.