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How to Calculate Payroll and Income Tax Deductions

by Tim AustinApril 15, 2019 8:00 AM

As an employer, you have a responsibility to handle every step of your business’ payroll. One of the more notable steps is handling the tax deductions that are withheld from every employee’s gross wages. To help, we’ve put together some pointers on how you can calculate the various deductions found on each paycheck.

A small business owner calculating payroll deductions for employees.

How to Calculate Payroll Taxes (FICA)

The term “payroll taxes” refers to FICA taxes, which is a combination of Social Security and Medicare taxes. These taxes are deducted from employee paychecks at a total flat rate of 7.65 percent that’s split into the following percentages:

  • Medicare taxes – 1.45 percent
  • Social Security taxes – 6.2 percent

These percentages are deducted from an employee’s gross pay for each paycheck. For example, an employee with a gross pay of $1,000 would owe $62 in Social Security tax and $14.50 in Medicare tax.

How to Calculate Federal Income Taxes

There are two main ways that you can calculate federal income tax withholdings. The IRS allows owners to choose which method they prefer and provides tables to help them determine withholding amounts. These methods are:

  • The wage bracket method
  • The percentage method

Wage Bracket Method

The wage bracket method is the easier of the two methods to use for one big reason: You can simply look up withholding amounts on specific tables instead of doing any actual math. These 2019 tables are found on pages 48-67 of the IRS’ Publication 15. To figure out which right chart for an employee, you need to identify two factors:

  • Whether an employee is single or married
  • How often that employee is paid (daily, weekly, monthly, etc.)

Once you have that information and find the right chart, you just need to determine the withholdings by lining up how much an employee made in a payroll period along with the number of withholding exemptions that your employees claimed on their W4 forms. For example, a married employee who made $1,000 on a weekly pay period and claimed two withholding allowances would have $66 in federal income tax withheld from his or her paycheck.

Percentage Method

Unlike the wage bracket method, the percentage method requires you to do some math. The first step is to multiply an employee’s total number of withholding allowances by the allowance amount associated with your specific payroll period. These amounts are found on Table 5 in Publication 15, but we also included them below.

  • Weekly – $80.80
  • Biweekly – $161.50
  • Semimonthly – $175
  • Quarterly – $1,050
  • Semiannually – $2,100
  • Annually – $4,200
  • Daily (for each day of a payroll period) – $16.20

Once you multiply the number of allowances by the associated allowance amount, you’ll then subtract that total from the employee’s taxable wages for that pay period. Let’s return to that married employee from the wage bracket example who makes $1,000 per week and claimed two exemptions. You would multiply the weekly amount ($80.80) by two, which results in a total of $161.60. That total is subtracted from $1,000, which leaves you with $838.40. 

Now that you have the total amount subject to income tax withholding, you need to refer to the percentage method tables on pages 46-47 of Publication 15 to determine the estimated withholdings. The process here can be tricky. You’ll need to find the chart that aligns with your employee’s pay period and marriage status. We’d use the following chart in Publication 15 for our example.

Percentage method chart for federal income tax deductions. 

Our total salary subject to withholdings is $838.40, so the amount of income tax to withhold is $37.30 plus 12 percent of the amount over $600. This means that we’ll need to subtract $600 from $838.40, which leaves us with $238.40. We can now determine 12 percent of that amount, which leaves us with $28.608. Add that to the $37.30 stipulated in the chart and the total federal income tax withholdings for the example employee is $65.908, which is rounded to $65.91. The IRS also allows you to round withholdings to the nearest whole dollar, which would make our example withholdings $66, which is the same amount as we found through the wage bracket method (but with much less work).

How to Calculate State and Local Income Taxes

Unlike federal income taxes, you don’t get to dictate which method you use to calculate payroll deductions for state income taxes. Each state has its own set of rules regarding how much you need to withhold from your employees’ paychecks. In fact, some states don’t require you to do anything at all, as Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not impose income taxes on its citizens. 

On the flipside, there are several states that require you to withhold both state and local income taxes, including Ohio, Michigan, and many others. Other states have multiple tax brackets that you’ll need to use to determine the right deduction amounts for each paycheck. To determine how to calculate these taxes – if there are any – you’ll need to consult your state government’s site for exact detail. However, independent tax policy nonprofit The Tax Foundation does have a datasheet with all the 2019 state individual income tax rates and brackets for reference.

How to Calculate Voluntary Paycheck Deductions

While FICA, federal income tax, and state and local income taxes all require mandatory payroll deductions, there are some other voluntary sources that could lead to additional paycheck withholdings. Potential voluntary paycheck deductions include:

  • Health insurance – Based on the plans offered and which of those plans your employees choose
  • Retirement – Based on how much each employee opts to have withheld from each paycheck
  • Life insurance – Based on whether employee opts to have deductions to go toward a life insurance premium
  • Job expenses – Varying deductions based on any business expenses made by an employee that are either not or only partly covered by the employer

The Importance of Proper Payroll Management

Payroll management for a small business is no simple task. Not only do you have to handle payroll taxes for every single one of your employees, you also must make sure that these deductions are done correctly every time – don’t forget, you have to report these taxes throughout the year. 

Between the overall payroll workload and the threat of potential IRS fines and other punishments, the typical small business owner is under a lot of pressure. You don’t have to handle payroll alone, however. GMS can partner with you to provide professional payroll tax management so that you can focus on growing your business instead of brushing back up on your math skills.

Ready to streamline your payroll process and other important business functions? Contact us today to talk to one of our experts about how we can help you and your business.

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