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How to Calculate Payroll Taxes

Written by:

Mark Stewart is the in-house Certified Public Accountant, an accomplished author and financial media specialist.

Reviewed by:

Daniel Eisner is a payroll specialist with over a decade of practical experience in senior accounting positions.

How to Calculate Payroll Taxes

How to Calculate Payroll Taxes

If you’re starting a business and hiring employees, payroll will likely be one of your first major challenges. Processing payroll can be quite complex, particularly when it comes to payroll taxes. 

Calculating payroll taxes correctly is critical to staying in compliance with the law, so you really need to know what you’re doing. Luckily, this handy guide spells out the entire process for you. 

What Are Payroll Taxes?

Payroll taxes withheld from employee paychecks fund Social Security and Medicare, to which employers also make payroll tax contributions. Social Security and Medicare taxes are together known as FICA taxes, which stands for Federal Insurance Contributions Act. 

The Social Security tax is paid by both the employee and the employer at 6.2% of the employee’s wages. The Medicare tax is also paid by both the employee and the employer, but at a rate of 1.45% of employee compensation.

For Social Security, there is a maximum wage limit. As of the 2022 tax year, if an employee makes more than $147,000, Social Security taxes do not have to be withheld. Medicare does not have a maximum wage limit, but any individual that earns more than $200,000 per year must pay an additional 0.9%.

Employers are also required to pay taxes under the Federal Unemployment Tax Act (FUTA) and the State Unemployment Tax Act (SUTA). States may also have their own payroll taxes that must be paid, so be sure to check with your state tax department.

Note that credits (reductions) for both FICA and FUtA taxes are available for certain industries, so check with your tax advisor to see if you qualify. 

Calculating Employee FICA Taxes

First, you’ll need to calculate your employee’s gross pay. 

If you have salaried employees, gross pay is simply their contracted fixed pay amount, such as $4,000 per month. For hourly employees, calculating gross pay takes a bit of work, but is still rather easy. 

First, review their timesheets to make sure they have accurately tracked their hours. Then multiply their hours for that week, or month, by their hourly rate. So if your employee Jane works 40 hours in a week at $15 per hour, her gross pay (40 x 15) is $600. 

Keep in mind that federal overtime law dictates that any hours over 40 in a week must be paid at 1.5 times the employee’s normal pay rate. If you fail to pay your employees the correct overtime rate, your business could face serious fines and penalties. Your state may also have specific overtime requirements.

Once you know the gross pay, just multiply that amount by the Social Security and Medicare tax rates. 

So Jane would pay:

$600 x 6.2% = $37.20 in Social Security tax

$600 x 1.45% = $8.70 in Medicare tax

Her total FICA tax is: $37.20 + $8.70 = $45.90

Calculating Employer FICA Taxes

Calculating your employer-paid FICA taxes is the same. You’ll start with gross pay and multiply it by the tax rates. For Jane, you’d be required to pay the same $45.90.

Calculating FUTA and SUTA Taxes

FUTA and SUTA taxes are paid only by the employer

The FUTA tax rate is 6% and its taxable wage base is $7,000, which means the tax only applies to the first $7,000 an employee makes that year. Once an employee’s compensation reaches that total, you no longer have to pay FUTA taxes. So for Jane, before she’s reached the $7,000 limit, you’ll pay:

$600 x 6% = $36 in FUTA taxes

Each state determines its own SUTA tax rate and taxable wage base. Many states have a range of SUTA rates and state governments regularly send employers updates on their tax responsibilities. 

Check with your state government for your SUTA tax rates. 

Note that in some situations, credits are available to reduce FUTA taxes. You can find more information on the IRS website, but you should also, again, consult your tax advisor. 

What About Income Taxes?

Income tax is paid by the employee at the federal, state, and local levels. At the federal level, the rate depends on the employee’s tax bracket. State and local taxes may or may not have fixed rates.

The amount withheld for federal income tax depends on the employee’s W-4, which should be filled out at the time of hire. The W-4 specifies the employee’s filing status, dependents, and additional withholding requests. To calculate federal income tax withholdings, refer to IRS Publication 15

In states that charge income tax, and most do, employees will also fill out a state withholding form. To calculate state income tax, refer to state-specific resources. The same is true for local taxes. 

Using a Payroll Service

As you might have guessed, processing payroll and paying taxes can be terribly complex, which is why many business owners turn to a payroll service provider. It’s often less expensive than creating a new staff position for managing payroll. 

Payroll and payroll taxes come with countless laws, rules and restrictions, and a payroll service can ensure your business remains in compliance at the federal, state, and local levels.

Just send over your digital timesheets and relevant employee and business information and the service provider will take care of the calculations, payments and taxes, freeing you up to focus on running, and growing, your business. 

We highly recommend hiring a payroll service — as a busy entrepreneur, you won’t regret it!