How Are Payroll Taxes Calculated – A Step-By-Step Guide

Now, more than ever, small business owners find computing payroll taxes increasingly challenging. Having to look after the intricacies of their business, and strategize for growth, they are left with little to no time to let the complicated IRS tax code test their ability to handle everything from soup to nuts. Besides, keeping your eye on the ball with regard to changes with the IRS, and managing appropriate deductions under FICA, FUTA and SUTA all at the same time become overwhelming, to say the least.

That being said, you cannot push aside payroll tax computation. The good news is that despite being complicated, once you understand what tax filings are required and how are payroll taxes calculated, the process doesn’t seem to be too intimidating. Let us guide you on how to calculate payroll taxes step by step.

 

 

When we say payroll tax, it’s not a single tax we are referring to. In fact, the term is inclusive of all the taxes that you are bound to pay on the salaries and wages of your employees.

 

Let’s dive into what are the different payroll taxes and how are payroll taxes calculated:

Employers withhold a certain percentage of the employees’ wages as federal income tax and remit it quarterly to federal, state and local authorities. Thinking how much tax to withhold and how are these payroll taxes calculated? For that, use the employee’s Form W-4, and follow the method and the appropriate withholding table described in Publication 15-T, Federal Income Tax Withholding Methods.

First of all, you will need a copy of the employee’s Form W-4, as well as their gross pay.

Next, you will calculate withholding. You can either use the wage bracket method or the percentage method. Better to choose the former as it is less complicated for calculating the payroll taxes.

 

Let’s find out how you can calculate federal income tax withholding using the Wage Bracket Method:

• – Locate the tables marked “Wage Bracket Percentage Method Tables” in IRS Publication 15-A. Match it with your employee’s pay period.
• – Look for the marital status of the employees on Form W-4 as well as the number of allowances they claim.
• – You will see pay period in columns A and B. Find the corresponding employee’s gross wage. The wage should be not less than the amount found in column A and not more than found in column B.
• – Deduct the amount found in Column C.
• – Multiply the remaining amount by the percentage found in Column D.
• – To the final amount, add additional tax withheld from each paycheck, provided it is requested by the employee on Form W-4.
• – There you go! The amount you calculated here is what you should withhold from the employee’s paycheck for that pay period.

Got a hang of how these payroll taxes are calculated? Let’s move on to another type of payroll tax.

Once you’ve calculated how much federal income tax to withhold from your employees’ paychecks, the next thing to do is to find out how much FICA to withhold, and how much you’ll be required to pay on their behalf.

 

Wondering what FICA is?

FICA or “Federal Insurance Contributions Act” Tax is a federal payroll contribution shared by both the employer and the employees to fund older Americans their Social Security retirement and Medicare (Hospital Insurance for senior citizens over 65) benefits through a mandatory payroll deduction of 6.2% and 1.45% respectively. These payroll taxes are contributed by you and your employees, splitting the sum of these deductions 50/50. The employee pays 50% from their paycheck while the employer pays 50% out of their revenue, each paying 7.65%. This means that the employee and the employer pay 15.3% altogether.

FICA is reported quarterly using Form 941 – Employer’s Quarterly Federal Tax Return. Now let’s figure out how this payroll tax is calculated.

As mentioned above, a Social Security tax rate of 6.2% is levied on each employee while you also pay a matching 6.2% for each employee, making it to be 12.4% in total.

To calculate Social Security withholding, multiply your employee’s gross pay for the current pay period by the current Social Security tax rate (6.2%).

Employee A gross pay for the current pay period X current Social Security

tax rate = Social Security tax to be deducted from employee’s paycheck

$2,000 X .062 = $124

and the same $ 124 to be contributed by you from your revenues.

Do keep in mind that the Social Security wage base is $142,800 for 2021. Hence, if the employees’ gross taxable earnings for the year amount to $142,800, there won’t be any deduction or contribution for the Social Security taxes from their paychecks and your business income respectively.

1.45% of each employee’s wages goes into Medicare tax. The employer is also required to contribute a matching 1.45%.

To calculate Medicare withholding, multiply your employee’s gross pay for the current pay period by the current Medicare rate (1.45%).

Employee A gross pay for the current pay period X current Medicare tax

rate = Medicare tax to be deducted from employee’s paycheck

$2,000 X .0145 = $29

and an equal amount to be contributed by the employer

Unlike the Social Security withholding, there is no wage base limit for Medicare taxable wages. Rather, the employees are taxed an additional 0.9% after an employee earns a certain wage. This additional Medicare tax is based on the filing status of the employees.

Single: $200,000

Married filing jointly: $250,000

Married filing separately: $125,000

This will lead to a deduction of 1.45% plus the 0.9% additional Medicare tax in case the employees reach the above-mentioned limits. Employers are exempted from contributing to the additional Medicare tax.

Using the above example, you would deduct $124 for Social Security tax and $29 for Medicare tax from the employee A paycheck and pay the same out from your pockets, to remit a total of $2000 * 15.3% = $306. You will continue to pay this amount until there is a change in Employee A’s wages or their earnings cross the Social Security wage base limit.

Let’s suppose the filing status of employee A is single; so, once the employee earns above the threshold of $200,000, Social Security tax would not be withheld or contributed. Adding the regular Medicare tax rate (1.45%) to the additional Medicare tax rate (0.9%), you will withhold a total of 2.35% for Medicare only.

An abbreviation for Federal Unemployment Tax Act, FUTA Tax is a federal tax imposed on employers to help fund unemployment insurance. The tax burden is imposed solely on employers who pay wages to the employees. The total amount is 6.0% on the first $7,000 wages paid to employees in a tax year. However, employers pay 0.6% only as most states receive a 5.4% credit to cover the remaining FUTA payments. As it’s a simple math, you wont be at your wit’s end thinking how to calculate this payroll tax.

FUTA is reported on Form 940 – Employer’s Annual Federal Unemployment Tax Return at the end of the financial year.

It’s a self-employment tax also known as the Self-Employment Contributions Act tax. It consists of Social Security and Medicare tax primarily levied on individuals who work for themselves.

The entrepreneurs are liable to pay a total of 15.3% towards Social Security and Medicare taxes. Of the 15.3% total SECA tax, 12.4% goes to Social Security and 2.9% goes to Medicare tax. Once your earnings increase above $142,800 in a taxable year, you won’t be required to pay the 12.4% Social Security tax portion. However, if your gross taxable self-employment income goes above the additional Medicare tax threshold, you will be required to pay 0.9% for Medicare tax in addition to the 2.9%. Sounds confusing? It won’t be once you learn how to calculate payroll taxes.

 

 

File Schedule SE to find out the amount of self-employment tax you should pay during the tax year. You should attach IRS Schedule SE to Form 1040, U.S. Individual Income Tax Return.

Let’s suppose your total earnings amounted to $185,000 in a calendar year. You will apply the Social Security tax (12.4%) only up to $142,800 – your income base.

$142,800 X 0.124 = $17,707.20

Now, let’s calculate your Medicare tax liability on your entrepreneurial income. The Medicare tax for SECA is 2.9%, so:

$185,000 X 0.029 = $5,365.00

As your earnings are less than the threshold of $200,000, you are not liable to pay the additional Medicare tax. Hence,

Your total SECA tax liability for 2021 would equal $23,072.00 ($17,707.20 + $5,365.00).

The State Unemployment Tax Act (SUTA) tax is a type of payroll tax that states withhold from employees’ paychecks. Being governed at the state and local level, state and local payroll taxes vary from state to state as such taxes are subject to the different tax rules of individual states. However, when it comes to calculating payroll tax such as SUTA tax, it’s done in almost the same manner as federal income taxes.

Generally, small business owners are responsible for paying SUTA taxes. However, if you have employees in states such as Alaska, New Jersey, and Pennsylvania, that require employee SUTA withholding too, you’ll be liable to withhold SUTA taxes from their wages and remit the tax to the state.

See Also: A Small Business Guide To Payroll Management

The above is the most comprehensive way to understand how to calculate the payroll taxes under each Act. Having said that, if you are still finding payroll to be a hard nut to crack, you can always outsource this function to a payroll management service provider. Monily has helped thousands of businesses over the years manage their payrolls conveniently and has guided them on how to calculate the payroll taxes. Our accounting experts and financial advisors do the nitpicky and pesky calculations for all startups, small and medium-sized businesses. What may appear complex to you is a breeze for our payroll experts.

Schedule a free consultation today and let our experts handle this daunting function of payroll tax calculation for you.

 

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