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How to Calculate Payroll & Income Tax Deductions

As an employer, understanding how to calculate payroll tax and income tax deductions is essential to running a compliant and efficient business.. A major part of that is making sure every employee’s paycheck has the correct taxes and other deductions withheld. Below is an overview of some of the most important payroll deductions for 2025, along with pointers on how to calculate them.

Calculating Payroll Taxes for Employees

The term payroll tax typically refer to Federal Insurance Contributions Act (FICA) taxes, which include both Social Security and Medicare contributions. For 2025, the employee-share rates remain:  
  • Social Security: 6.2% of gross wages
  • Medicare: 1.45% of gross wages
This totals 7.65% for most employees, withheld each pay period. For example, if someone’s gross pay is $1,000:
  • Social Security withheld = $1,000 x 6.2% = $62
  • Medicare withheld = $1,000 x 1.45% = $14.50
  • Total Payroll Tax withheld = $76.50
Meaning every paycheck for that employee will have $76.50 withheld.

How to Calculate Federal Income Tax Deductions

Unlike the flat rates for Social Security and Medicare, income tax deductions are determined by the employee’s Form W-4 and IRS tax tables. The IRS has 2025 Form W-4 instructions and updated tables in Publication 15-T. You can generally calculate withholding using either the wage bracket method or the percentage method. Wage bracket method This method uses easy-to-read tables. You simply:
  1. Look up how frequently you pay employees (weekly, biweekly, semimonthly, monthly, etc.).
  2. Choose the correct table based on the employee’s filing status (from the Form W-4) and whether they’ve checked the Step 2 box.
  3. Find the wage range in the table; the table cross-references the amount of tax to withhold based on any additional adjustments entered on the W-4.
Percentage method This approach involves a bit more math, but it may be more flexible if your payroll amounts frequently exceed the ranges in the wage bracket tables. You will:
  1. Convert allowances (if you still have employees on 2019 or earlier W-4s) or interpret the relevant steps if they’re using a 2020 or later W-4. (For 2019/pre-2020 forms, note that the IRS publishes a “computational bridge.”)
  2. Subtract any allowances (or standard W-4 adjustments) from gross wages to get the taxable portion for that pay period.
  3. Apply the percentage method table.
  4. Add or subtract any additional amounts indicated on the employee’s W-4.

Understanding State and Local Payroll Tax Withholding

State And Local Taxes Federal income taxes aren’t the only concerns; many states and local governments require payroll tax withholding for state and local income tax deductions.. The method differs from state to state:
  • Some states (e.g., Florida, Texas) do not impose state income tax, meaning you only handle federal deductions.
  • Others (e.g., Ohio, New York) require both state and sometimes local income tax withholdings.
  • Check your state government’s website or official documentation for the 2025 rates and instructions.

Additional (Voluntary) Paycheck Deductions

In addition to required taxes, some income tax deductions are voluntary and may be either pre-tax (which reduce taxable income) or post-tax: These can include:
  1. Health insurance premiums for medical, dental, vision, etc.
  2. Retirement contributions (e.g., 401(k), IRA) chosen by the employee.
  3. Life insurance premiums paid via payroll deduction.
  4. Job-related expenses if you have agreed to recoup certain business expenses through paychecks (where legal).
Ensure that these are set up correctly in your payroll system. Some might be pre-tax (reducing taxable wages), while others are post-tax.

Why Payroll Tax Compliance Matters

Staying accurate and up to date on payroll laws and tax tables is vital. Miscalculating payroll tax or income tax deductions can result in underpayment or overpayment, leading to potential penalties from the IRS or your state’s tax authority. It also impacts employees directly; over-withholding means smaller paychecks, while under-withholding can mean a big tax bill in April.
  • You’re responsible for timely depositing withheld taxes with the IRS, as well as filing the proper forms (like Forms 941 or 944 for federal payroll taxes).
  • For 2025, be sure you’re referencing the latest versions of IRS Publication 15 (Circular E) and Publication 15-T (2025) for the updated wage bracket or percentage method tables.

Let GMS Simplify Your Payroll Tax Process

Handling small business payroll taxes can be daunting, especially as forms and laws evolve each year. Group Management Services (GMS) can take the guesswork out of payroll tax and income tax deductions, ensuring accurate withholdings, filings, and tax deposits. If you’re:
  • Worried about maintaining compliance for 2025.
  • Unsure how to handle different forms (e.g., older 2019 W-4 forms vs. new 2025 W-4 forms).
  • Concerned about multi-state or local tax withholding.
Group Management Services (GMS) can help streamline all aspects of your payroll tax management, from accurate withholdings to timely tax filings, allowing you to focus on growing your business. Contact GMS to learn more about our payroll tax services and how we can help you navigate the complexities of income tax deductions.