How to Calculate Payroll Taxes for Small Business

Calculating your payroll taxes correctly is critical in order to avoid any back taxes or fines and ensure that your employees can benefit from as many tax allowances and deductions as they are able to. 

In this guide, we explore the steps that you will need to consider before calculating your payroll taxes, how you can calculate your employees’ net pay, and what forms you will need to file after your payroll has been calculated correctly in order to comply with IRS guidelines.

Steps Before Calculating Payroll Taxes

In order to calculate your payroll taxes correctly, your employees will need to provide you with the following documents:

You will also need to: 

  • Set up a separate payroll bank account
  • Receive authorization to pay your employees
  • Know your state’s payday due dates

Form W-4

The IRS refers to Form W-4 as a “withholding certificate.” This is because it details your employees’:

  • Personal information
  • Filing status
  • Number of dependants
  • Income and applicable deductions
  • Additional withholdings

This means that before you can think about calculating your payroll taxes, you will need to ensure that all of your employees have completed a Form W-4. 

State W-4s

Keep in mind that the majority of states also have state W-4 withholding forms. This must be completed by your employees unless you operate in a state with no state income tax. 

For more information on state W-4s, see the state-specific list on the Federation of Tax Administrators website.

Form I-9

Form I-9 is an “employment eligibility verification” form. It certifies that your employees are legally allowed to work within the US. 

According to the IRS, every employee (citizen or noncitizen) is required to fill out a Form I-9 before they begin working.

Set Up a Separate Payroll Account

Even though this is not a legal requirement, you should consider setting up a separate payroll bank account before calculating your payroll. 

This can help you to track the funds that you have paid to your employees and the amount that you will be required to pay in payroll taxes in the future.

Receive Authorization to Pay Your Employees

If you plan to pay your employees through a direct deposit, you will need to receive a direct deposit authorization form. This is a legal requirement within the US and acts as proof that your employees have consented to that form of payment.

Before setting up your payroll taxes, you will want to decide how you will be paying your employees, as well as what regulations that will entail.

Know Your State’s Mandated Payroll Schedule

Employers have some discretion over how often they choose to pay employees, but they must satisfy their state’s minimum payday requirements:

These can be broken down into four categories:

Monthly States

Semi-Monthly States

States With Multiple Payday Requirements

  • Connecticut: Weekly. Longer payday intervals of up to monthly can be allowed if approved by the labor commissioner.
  • Hawaii: Semi-monthly. Workers can choose to be paid monthly under a special election procedure. Exceptions can also be granted by the Director of Labor.
  • Illinois: Semi-monthly. Monthly for executive, administrative, and professional personnel.
  • Louisiana: Biweekly. Employers with 10 or more workers operating in manufacturing, mining, or boring for oil and public service corporations may pay workers semi-monthly.
  • Massachusetts: Semi-monthly. Monthly pay dates are allowed in specific circumstances.
  • Minnesota: Monthly. This is reduced to semi-monthly for workers in transitory employment and in public service corporations.
  • Nevada: Semi-monthly. Monthly for executive, administrative, and professional personnel.
  • New Hampshire: Weekly or biweekly. Exceptions can be granted by the NHDOL.
  • New Jersey: Semi-monthly. Executive, supervisory, and other “special classifications” of employees may be paid monthly.
  • New Mexico: Semi-monthly. Monthly for executive, administrative, and professional personnel.
  • New York: Semi-monthly. Weekly pay for manual workers
  • Rhode Island: Weekly or semi-monthly. Childcare providers can be paid biweekly if they choose to.
  • Texas: Semi-monthly. Employees exempt from the overtime provisions of the Fair Labor Standards Act may be paid monthly.
  • Utah: Semi-monthly. Employees on an annual salary may be paid monthly.
  • Vermont: Weekly. Employers may implement by-weekly or semi-monthly pay as long as sufficient written notice is provided
  • Virginia: Biweekly or semi-monthly. Employees whose weekly wages exceed 150% of the average weekly wage of the Commonwealth or who are classified as “executive, administrative, and professional personnel” may be paid monthly.
  • Wisconsin: Monthly. Certain classifications of employees (e.g., those engaged in logging, farm labor, etc.) may be paid quarterly.

Unregulated States

  • Michigan (dependant on occupation)
  • Montana (Presumed semi-monthly unless otherwise stated in an employment contract.)
  • North Carolina
  • Pennsylvania
  • South Carolina

Calculating Payroll Taxes

The next step is calculating how much you will need to pay in payroll taxes. 

This is generally done by completing the following steps:

  • Calculating your employees’ gross pay
  • Calculating your tax withholdings
  • Calculating your employees’ pre and post-tax deductions

Calculating Gross Pay

Your employees’ gross pay is the total amount that they are owed before any deductions are made. 

If you pay your employees an hourly rate, calculating their gross pay can be done by simply multiplying the number of hours they worked with the pay they receive each hour. For example, a person working 40 hours a week on $15 per hour will have a weekly gross pay of $600. 

For employees on an annual salary, you can simply divide their total salary by the number of pay periods in a year. Keep in mind that workers that make less than $35,568 per annum are required to be paid an overtime rate for hours that exceed 40 a week.

Calculating Tax Withholdings

The next step is calculating what percentage you will need to withhold from your employees’ wages in each pay period.

You will need to withhold wages for:

  • Local, state, and federal income taxes
  • Medicare and Additional Medicare taxes
  • Social Security taxes

There are a few points that you should keep in mind:

Social Security 

The Social Security tax rate in 2021 is 6.2%. In addition to this, you will be required to contribute an equivalent amount individually. 

This means that the total amount that will need to be deposited and reported to the IRS for Social Security tax is 12.4% of an employee’s salary.

Keep in mind that Social Security tax is only applicable for the first $147,000 of a person’s salary. Any amount that exceeds this per annum is not subject to any Social Security tax. 

Medicare and Additional Medicare

The Medicare tax rate is 1.45%. Similarly to Social Security taxes, employers are required to contribute an equivalent amount individually. 

This means that the total amount that will need to be deposited and reported to the IRS for Medicare tax is 2.9% of an employee’s salary.

Any employee making over $200,000 a year is subject to an additional tax of 0.9%, known as Additional Medicare tax. Withholdings for this are strictly applied after an employee has received more than $200,000 a year, even if their filing status allows them to benefit from a different income threshold. 

For example, even if an employee’s filing status means that their income threshold for Additional Medicare tax is increased to $250,000 per annum (i.e., married and filing jointly), employers are still required to begin withholding Additional Medicare from $200,000 onwards.

Employees can then claim the amount owed (0.9% of $50,000) at the end of the year. 

FUTA and State Unemployment Taxes

Federal unemployment taxes (FUTA) and state unemployment taxes are not withheld from your employees’ salaries. They are instead contributed solely by you as the employer. 

According to the general test provided by the IRS, you are required to pay FUTA tax if:

  • You paid wages of $1,500 or more per annum.
  • You had one or more employees for at least 20 weeks per annum. (Temporary and part-time employees are included.)

The FUTA tax rate in 2021 is 6.0% — which applies to the first $7,000 of an employee’s salary — but this can be reduced by up to 5.4% if state unemployment taxes have been paid in full. 

For more information, see the IRS Form 940 “About” section.

Local, State, and Federal Income Taxes

Income tax is a progressive tax. This means that it will ultimately depend on your employees’ salary. The higher the salary, the larger the percentage that you will have to withhold for income taxes.

Not every state has local or state income taxes. You will need to check with your state’s laws before determining how much to withhold from each employee. 

For more information, see the IRS Publication 15-T.

Make Pre-Tax and Post-Tax Deductions

Finally, you will need to subtract all of your employees’ pre and post-tax deductions to determine their net pay. 

Examples of pre-tax deductions include:

  • Medical benefits
  • 401(k) retirement plans
  • Disability insurance
  • State income taxes

Examples of post-tax deductions include:

  • Charitable donations
  • Union dues
  • Garnishments

Steps After Calculating Payroll Taxes

After you have calculated your payroll taxes, you will need to follow a few final guidelines. These include:

  • Depositing payroll taxes
  • Reporting payroll taxes
  • Filing a Form W-2 and Form W-3 for each employee

Depositing Payroll Tax

You will need to deposit your payroll taxes on a monthly or biweekly basis.

For more information on determining your payment schedule, see Publication 15 on the IRS website for Forms 941, 944, and 945, and Publication 51 for Form 943.

Tip: You can deposit payments electronically through the Electronic Federal Tax Payment System (EFTPS)

Reporting Payroll Tax

When reporting your payroll taxes, you will need to use a different form depending on the type of tax:

You may need to use additional forms depending on the circumstances:

  • Agricultural workers (Form 943)
  • Backup withholding (Form 945)
  • Employers who have received written notification to use the Form 944 program: Form 944

The IRS generally recommends that employers report payroll taxes electronically through E-File. These can also be reported through the post. 

The specific address for each form will depend on your state:

Filing W-2 and W-3 Forms

As an employer, you are required to file both a Form W-2 and a Form W-3 with the Social Security Administration (SSA) for every person that you employ if your business pays at least $600 per annum in payroll taxes. 

When completing your forms, make sure you follow the IRS guidelines:

  • Type all of your entries using blank ink
  • Leave non-applicable boxes empty
  • Omit dollar signs and commas
  • Keep the forms mistake-free

All employers with 250 or more W-2 forms are required to file these electronically unless contrary permission is granted by the IRS. 

If you wish to file your Form W-2s and W-3s by post, you will need to order scannable copies either through the IRS website or by calling 1-800-829-3676. These will then need to be submitted to the SSA by January 31 at the following address:

Social Security Administration
Direct Operations Center
Wilkes-Barre, PA 18769-0001

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Frequently Asked Questions

Are payroll taxes regressive?

Generally, yes. This is because payroll tax rates do not increase based on individuals’ salaries:

  • Social Security: 6.2%
  • Medicare: 1.45%
  • Additional Medicare: 0.9%

 The only exception to this is federal income tax.

Can I do payroll taxes by myself?

Generally, there are four ways for employers to handle their payroll taxes. These include:

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

You can legally handle your payroll taxes by yourself, but this may be very time-consuming, depending on your experience and knowledge when it comes to US taxes.

You may also face fines or back taxes as a result of accidentally missing a deadline or miscalculating the withholding amounts of that you should have made.

Do I need to pay Social Security tax?

Employees will only need to pay Social Security tax for the first $147,000 that they make.

The Social Security tax rate is a fixed rate of 6.2%. Employers need to contribute an additional 6.2% themselves.

What are payroll taxes used for?

Most payroll taxes aim to fund social costs. These include:

  • Healthcare services (Medicare)
  • Social security
  • Unemployment support (FUTA)

Federal income tax, as the US government's largest source of income, is used more discretionarily but generally includes:

  • Educational funding
  • Infrastructure repairs
  • Industry subsidies
  • Police funding

How does my filing status affect Additional Medicare tax?

Your filing status can affect the income threshold that you will need to exceed in order to start paying the Additional Medicare tax rate of 0.9%. 

This threshold depends on your IRS tax filing status:

  • Married filing jointly: $250,000
  • Married filing separately: $125,000
  • Single: $200,000
  • Head of household: $200,000
  • Qualifying widow(er) with dependent child: $200,000