Everyone knows that sinking feeling when they look at their paychecks and see a big chunk ofchange deducted for Uncle Sam. For businesses that handle payroll manually, calculatingemployees’ payroll taxes typically elicits the same level of enthusiasm. But even ifthey outsource the critical task to a payroll service or use an automated payroll system,employers should still understand the different types of taxes to withhold, which ones theymust contribute to or pay in full out of their own revenue and the basic calculations.
What Is Payroll Tax?
Payroll tax is a catchall term that includes all of the taxes paid on employee wages. Thereare two types, employee-paid taxes and employer-paid taxes.
- Employee-paid taxes: These are the taxes an employer withholds fromemployees’ paychecks to remit to the government on the employees’ behalf.They include federal, state and local payroll taxes.
- Employer-paid taxes: These are the taxes an employer pays to thegovernment out of the employer’s own revenue, such as unemployment taxes and halfof Medicare and Social Security taxes.
Key Takeaways
- Every employee must pay payroll taxes, including federal and state income taxes, SocialSecurity and Medicare.
- Employers are responsible for withholding payroll taxes from their employees’paychecks and sending the money to the government.
- They must also match certain tax contributions, such as for Social Security andMedicare, and pay for others entirely.
- Calculating payroll tax is a multistep process that follows one of two methods.
Calculating Payroll Tax Explained
When a business pays its employees — whether they are salaried and paid by the hour— it withholds a portion of their taxable income and sends the funds to the governmenton their employees’ behalf. The business is also required to pay specific payroll taxesout of its own revenue for every employee. Payroll taxes include:
- Federal income tax. This tax is based on a percentage of anemployee’s gross income less pretax deductions, such as for medical benefits.Employees are solely responsible for paying federal income tax.
- FICA tax. FICA stands for the Federal Insurance Contributions Act. Thisis a tax for Social Security and Medicare. The employer must match the same amount thatit* employees pay with money from its own revenue.
- FUTA tax. FUTA stands for the Federal Unemployment Tax Act. Employersare 100% responsible for paying this federal tax, which is used for unemploymentinsurance and to fund state employment agencies.
- State and local income taxes. Forty-one states collect income tax fromworkers. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas,Washington and Wyoming are the exceptions. Whether local taxes are collected depends onwhere an employee lives.
- SUTA tax. SUTA stands for the State Unemployment Tax Act. This is astate tax that only employers pay, except in Alaska, New Jersey and Pennsylvania, whereemployees are partially responsible and employers remit on their behalf.
- State disability insurance. A few states — California, Hawaii,New Jersey, New York and Rhode Island — require employees to make payrollcontributions for programs that support employees if they become disabled while employedat their jobs. Employers are not required to contribute to state disability insurance.
Of note, businesses are not responsible for handling payroll taxes for independentcontractors. IRSPublication 15-A(opens in a new tab) providesguidanceon determining whether a worker is an employee or an independent contractor, thoughgenerally speaking anyone who gets a Form W-2, Wage and Tax Statement, is an employee.
How to Calculate Payroll Tax
When first starting out with just a few employees, a company may handle payroll, includingcalculating payroll taxes, manually. But as the business grows, it will likely become morepractical to outsource the job to a third-party payroll service or turn to software thatautomates the payroll process and scales withthe business.
Still, it’s a good idea for any business to understand the costs behind and the basics ofcalculating payroll tax, at the very least so they can accurately budget forpayroll. The first step is to determine the percentage of an employee’s wages thatmust be withheld for income taxes. Then FICA and FUTA taxes have to be calculated (more onthis later).
Federal income tax withholding is calculated using one of two methods: the wage bracketmethod or the more complicated percentage method. Both require information from anemployee’s Form W-4, Employee’s Withholding Certificate, and their gross pay.
Wage Bracket Method
The wage bracket method is used to determine withholdings for salaries up to $100,000. It isbased on an employee’s marital status and pay period. The wage bracket method relieson wage bracket tables to determine the exact amount of income taxes to withhold. Thespecific calculation steps depend on whether the employee’s W-4 was issued before orafter 2020. It’s important to note that each main step comprises a series of“mini”steps, as well. (IRS Publication 15-T(opens in a new tab) drills down on each.)
For W-4s from 2020 or later, the four main steps to calculate payroll taxes are:
- Adjust the employee’s wage amount. The employee’s adjustedwage amount is calculated based on the employee’s total taxable wages for thepayroll period and the number of payroll periods the employer has per year.
- Figure the tentative withholding amount. This is calculated by usingthe employee’s marital status and the employer’s payroll period to determinewhich wage bracket method table to use in Publication 15-T.
- Account for tax credits. The employee may be eligible for tax credits listed ontheir W-4, such as the child tax credit or the earned income tax credit, which lessenhow much tax is owed for the current pay period.
- Figure the final amount to withhold. This step adds any taxes to beapplied based on elections the employee made on their W-4 to withhold additional taxes,such as for pension or annuity payments.
For W-4s from 2019 or earlier, the two main steps to calculate payroll taxes are:
- Figure the tentative withholding amount. This is found using theemployee’s marital status plus the employer’s pay frequency to determinewhich wage bracket method table to use. It’s then calculated using theemployee’s total taxable wages and withholding allowances.
- Figure the final amount to withhold. This step adds any taxes to beapplied based on the election to withhold additional taxes on the employee’s W-4.
Percentage Method
The percentage method is used when an employee’s annual wages exceed the maximum amountfound in the wage bracket method tables. This requires more calculations than the wagebracket method so is used more frequently by employers working with automated payrollsystems or third-party payroll service providers. Like the wage bracket method, the stepsfor calculating payroll taxes using the percentage method depend on whether a W-4 was issuedpre- or post-2000. In either case, the main steps are mostly the same, though there are moresmaller steps. (Again, IRS Publication 15-T(opens in anew tab) lays out the specific details of each step.)
Components of a Pay Stub
A pay stub is typically attached to an employee’s paycheck (digital or paper),detailing wages, the amount withheld for payroll taxes and the number of hours worked.Employers have some freedom to choose what to put on their employees’ pay stubs, butindividual states may have specific requirements by law.
A typical pay stub contains the employer’s name, the employee’s name and SocialSecurity number, the pay period, number of hours worked, overtime and tips if applicable,and gross and net pay. It also lists withheld income taxes — federal and, ifapplicable, state and local income taxes — Social Security and Medicare (FICA),unemployment tax (SUTA) and state disability insurance. In addition, voluntary deductionsare itemized, such as for a 401K plan, healthcare plan and life insurance. All dollaramounts are presented two ways: per check and year to date.
Wages
Wages are monetary compensation that employers pay employees in exchange for servicesperformed over a specific time period. Wages typically include an employee’s salary,vacation pay, bonuses and commissions — all of which are subject to payroll taxes.Other types of taxable compensation are employee stock options, health savings accounts andtransportation benefits.
Income Tax Withholding
Income tax is precisely what it says: tax on income, which employers withhold fromemployees’ paychecks and remit to the government on their workers’ behalf.Employers are not required to withhold income taxes for independent contractors, who mustpay them on their own. Employers calculate federal income tax withholdings using either thewage bracket method or the percentage method, as described above.
FICA Withholding
The Federal Insurance Contribution Act (FICA) requires employers and employees to split thecost of taxes that go to Social Security and Medicare. Employers typically withhold 6.2% oftheir employees’ wages for Social Security and 1.45% for Medicare, match the amountfrom their own revenue and remit the total to the federal government. FICA is reportedannually on Form 941(opens in a new tab), Employer’sQuarterlyFederal Tax Return, and is due on the last day of the money following each quarter. The IRShas special rules to determine when the tax payment needs to be remitted.
FUTA
The Federal Unemployment Tax Act (FUTA) requires businesses to shoulder the cost ofunemployment insurance — 6% of an employee’s wages up to $7,000 annually. Theamount comes out of the company’s revenue. Most states offer up to a 5.4% FUTA taxcredit, which means employers wind up paying only 0.6%. FUTA is reported quarterly on Form 940(opens in a new tab), Employer’s AnnualFederalUnemployment (FUTA) Tax Return, and is due on the last day of the month following eachquarter.
Deductions
Withholdings are sometimes confused with deductions. Withholdings are taxes like income tax,social security, and medicare that employers deduct from their employees’ paychecksand remit to the government. Generally, the IRS determines the amounts withheld. Deductions,on the other hand, refer to employee-elected and paid-for benefits and donations, such asfor health care and retirement plans. Employers take the amounts out of employees’paychecks before calculating their taxes. Doing so lowers a person’s income, which mayreduce the amount of income tax they have to pay.
Pay Schedule
A pay schedule — also called a payroll schedule — establishes how often abusiness pays its employees. The four most common types are weekly, biweekly, bimonthly andmonthly. Some state laws regulate when an employer is required to pay its employees, sooptions for payroll schedules in those states are more limited. For example, NewYork’s Department of Labor has a mandatory minimum requirement that manual workers areto be paid on a weekly basis.
Local Factors
Local payroll taxes — also known as municipal taxes — are based on where abusiness’s employees work and live. They’re collected only in states thatcollect a state income tax and go toward funding schools, community improvements and otherlocal endeavors. Whether employers are required to contribute to their employees’local payroll taxes depends on the municipality, so it’s important to check with localtax departments.
How to Calculate FICA
The FICA tax funds Social Security and Medicare. Employers withhold the dollar amount theiremployees must pay, match that amount and remit the entire payment to the IRS.
- Social Security. Employees are required to pay 6.2% of their taxableincome for Social Security. For example, if an employee earns $1,000 in one paycheck,the employer withholds $62 and adds another $62 out of its own revenue, for a total of$124 sent to the IRS. In 2022, annual Social Security contributions were capped once anemployee earned $147,000; in 2023 the cap has been increased to $160,200. This maximumamount is called a wage-based limit.
- Medicare. Employees are required to pay 1.45% taxes for Medicare, andthe employer must match that amount. Otherwise, the deduction works the same as it doesfor Social Security. If an employee earns $1,000 in a paycheck, the employer withholds$14.50 for Medicare, matches the same amount from its revenue and remits a total of $29to the government. For any employee who makes over $200,000, the employer is required towithhold from the employee an additional 0.09% in income for Medicare — but itdoesn’t have to match the amount.
How to Calculate FUTA
FUTA taxes are employer-paid payroll taxes — employees do not contribute. Employers arerequired to pay 6% in taxes on each of their employees’ first $7,000 in wages. Moststates have a FUTA credit of 5.4%, so employers wind up paying only a 0.6% FUTA tax peremployee.
Stop Stressing About Payroll With NetSuite Financial Management
Employers always have the option to manually calculate payroll taxes, but the more employeesa business has and the higher their salaries are, the more complicated, time-consuming anderror-prone the payroll process becomes. Keeping track of the due dates for all thedifferent kinds of payroll tax can also be a burden on employers, which face up to a 15%penalty for remitting taxes late.
These are some of the reasons why many employers choose to use automated payroll software,namely NetSuite’s SuitePeople Payroll. TheSuitePeople Payroll System significantly reduces the amount of time it takes for a businessto run payroll, calculating how much in payroll taxes should be deducted fromemployees’ paychecks and then matching and/or remitting the funds to the government ontime. The solution is configurable to a business’s payment schedule, handles directdeposit and creates payroll reversals, if necessary. It also displays detailed payroll dataon easy-to-read dashboards and, like NetSuite Financial Management, automaticallyupdates the general ledger in real time.
Calculating payroll taxes can be complicated. Whether a business handles the job manually,outsources it or turns to an automated payroll system, the business will need to understandexactly how much in payroll taxes it’s responsible for, both for compliance and itsown financial purposes. This knowledge is also important to be able to answeremployees’ questions about their paychecks.
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Payroll Tax Calculation FAQs
What is employee payroll tax?
Employee payroll tax includes contributions to federal, state and local income tax, as wellas Medicare and Social Security. Employee payroll taxes are withheld by their employers, whor*mit the funds — at times, matching them — to the government on theiremployees’ behalf.
What is payroll tax percentage?
The payroll tax percentage is the percentage of an employee’s wage that is collectedfor payroll tax. The actual percentage varies depending on the type of payroll tax and theemployee’s tax bracket.
What is the formula for calculating payroll tax?
The formula for calculating payroll tax depends on which payroll tax is being calculated. Thedollar amount will depend on an employee’s gross pay less their deductions. Fromthere, the specific payroll tax percentage is applied.
How do I manually calculate payroll taxes?
Federal income taxes can be calculated manually using either the wage bracket method or thepercentage method. The wage bracket method uses referencing tables to determine withholdingfor employees with salaries under $100,000; it is the simpler method of the two because noadditional calculations are required. The percentage method is used by employers thatoutsource their payroll systems or use automatic payroll programs to calculate withholdings.
How much payroll tax is taken out of my paycheck?
The amount of payroll tax taken out of a paycheck depends on your gross pay. For SocialSecurity, you’ll owe 6.2% of your gross wages up to $147,000. For Medicare, it’s1.45%, plus an additional 0.09% if you earn over $200,000.
What is the percentage of federal income tax withheld?
The percentage of federal income tax withheld depends on what tax bracket an employee’swages fall under. The percentage starts at 10% and rises along with salary.
