How to Calculate Payroll Tax for Your Business

Payroll Tax: What Is It and How to Calculate It

The moment you take on your first employee, you become responsible for payroll taxes. Despite the name, payroll tax is not a single tax but a term that covers all taxes paid on an employee’s wages.

Even if you run a small business with no employees, you’ll still have to pay these taxes—for yourself. This is called self-employment tax, covering Medicare and Social Security, which amounts to 15.3% of your net business income.

Once you do have employees, payroll taxes can get a little trickier. Let’s break it down.

Types of Payroll Taxes

Since both your business and your employees are taxpayers, there are two types of payroll taxes:

1. Payroll taxes that come out of your own pocket: These are taxes paid by you, the employer.
2. Payroll taxes that you collect from employee paychecks: These are taxes withheld from employee paychecks and remitted to the federal government.

Payroll Taxes That Come Out of Your Pocket

• FICA tax: FICA contributes to Social Security and Medicare, with the cost shared between employers and employees. Employers contribute 6.2% for Social Security and 1.45% for Medicare. You’ll also collect the same amount from your employees and remit it.
• FUTA tax: FUTA contributes to unemployment insurance. The rate is 6.0%, but most states offer a 5.4% credit, so employers are generally responsible for only 0.6%.

Payroll Taxes That You Collect and Remit

• Federal income tax
• State and local tax

The percentage of federal income tax you withhold on behalf of your employees and then remit quarterly to federal, state, and local tax authorities. Calculating your employee’s federal income tax withholding starts with a copy of their Form W-4 and their gross pay.

There are two methods you can use in your calculations: the Wage Bracket Method or the Percentage Method. The Percentage Method is more complicated, but you can read about it in IRS Publication 15-T. The Wage Bracket Method is considerably more straightforward.

The Wage Bracket Method

Employees with a Form W-4 from 2019 or earlier:

1. In IRS Publication 15-T, find the worksheet marked “Wage Bracket Method Tables for Manual Payroll Systems With Forms W-4 From 2019 or Earlier.”
2. Check Form W-4 to determine whether the employee files income tax as married or single and the number of allowances they claim.
3. Enter the employee’s total taxable wages for the payroll period on line 1a. This includes any earnings an employee pays taxes on, including salaries and cash tips.
4. Use the amount on line 1a to look up the Tentative Withholding Amount. Find the table that corresponds to your payroll period (daily, weekly, biweekly, monthly, or annually) and the marital status of the employee (e.g., biweekly, and single if you run payroll twice a month and you’re calculating the tax for an unmarried employee)
5. Find the wage amount on the left side of the table. Once you’ve identified the row, use the number of allowances the employee has reported on Form W-4 to locate the corresponding column. The cell where these two meet will give you the tentative withholding amount for this employee.
6. Take the tentative withholding amount from this table and input it on line 1b.
7. On line 2a, enter any additional amount to be withheld as reported on Form W-4
8. Add lines 1b and 2a to find the amount to withhold from the employee’s wages and record it in line 2b.

1. In IRS Publication 15-T, find the worksheet marked “Wage Bracket Method Tables for Manual Payroll Systems With Forms W-4 From 2020 or Later.”
2. Check Form W-4 to determine whether the employee files income tax as married or single and the number of allowances they claim.
3. Enter the employee’s total taxable wages for the payroll period on line 1a. This includes any earnings an employee pays taxes on, including salaries and cash tips.
4. On line 1b, record the number of pay periods you have per year using Table 5 on the same page.
5. On line 1c, enter the other income amount found on Step 4a of the employee’s Form W-4. Divide this amount by the number of pay periods recorded on line 1c and write the amount down on line 1d.
6. Add up lines 1a and 1d and record the amount on line 1e. This is the employee’s total earnings from all income sources prior to any deductions the employee is eligible for.
7. On line 1f, enter the employee’s deductions amount as found on Step 4b of their Form W-4. Divide this amount by the number of pay periods and enter that amount on line 1g.
8. Subtract line 1g from line 1e, and you’ll get the Adjusted Wage Amount on line 1h. If the amount is 0 or less, enter 0.
9. Find the Tentative Withholding Amount by using the table that corresponds to your payroll period (daily, weekly, biweekly, monthly, or annually) and the marital status of the employee (e.g., biweekly, and single if you run payroll twice a month and you’re calculating the tax for an unmarried employee).
10. If the employee has applicable tax credits on Step 3 of their Form W-4, use lines 3a to c to determine how much applies to this pay period. Otherwise, record the amount from 2a on line 3c.
11. Finally, enter any additional amount to withhold from Step 4c of Form W-4 on line 4a. Adding this amount to line 3c gives you the amount to withhold from the employee’s wages, which you’ll record on line 4b.

Once you have completed your calculations for how much income tax to withhold, we’ll move on to how much FICA to withhold, and how much you’ll be required to pay on their behalf.

FICA Calculations

FICA is a mandatory payroll tax deduction used to pay for Social Security (disability insurance, old age, survivors) and Medicare (covering individuals over 65).

Funding FICA comes from 50% of your employees’ paychecks and 50% from you, the employer’s revenue. The current tax rate for social security is 6.2% for the employer and 6.2% for the employee (12.4% total). Medicare’s current rate is 1.45% for the employer and 1.45% for the employee (2.9% total), making up 15.3% of the total employee’s wages.

Calculating FICA payroll tax includes:

Social Security Withholding

• Multiplying your employee’s gross pay for the current pay period by the Social Security tax rate (6.2%). Deduct this amount from the employee’s paycheck and remind them with your payroll taxes.
• Example: $5,500 (employee’s gross pay for the current pay period) x .062 (current Social Security tax rate) = $341 (Social Security tax to be deducted from employee’s paycheck)

Medicare Withholding

• Multiply your employee’s gross pay by the current Medicare tax rate (1.45%).
• Example: $5,500 (employee’s gross pay for the current pay period) x .0145 (current Medicare tax rate) = $79.75 (Medicare tax to be deducted from employee’s paycheck)

Employer Matching

• You are also responsible for matching your employee’s FICA contribution; therefore, you would also remit $341 for Social Security and $79.75 for Medicare tax.

FUTA Calculations

FUTA is an employer-paid payroll tax that pays for state unemployment agencies. The FUTA tax rate stands at 6% on the first $7,000 of wages paid to employees in a calendar year, but employers only pay 0/6% since each state receives a credit covering the remaining 5.4% of FUTA payments.

FICA vs. FUTA

We’ve determined that FICA is a payroll tax contributing towards Social Security and Medicare, and FUTA contributions fund state workforce agencies and unemployment insurance. But they also require different tax forms. You’ll report FUTA on Form 940 – Employer’s Annual Federal Unemployment Tax Return at the end of the financial year. The due date is January 31.

You’ll submit FICA taxes quarterly using Form 941 – Employer’s Quarterly Federal Tax Return. The deadline is the last day of the month following the quarter. For example, if your quarter ends on March 31, the form is due on April 30.

Key differences:

• FICA: Funds Social Security and Medicare.
• FUTA: Funds unemployment insurance.
• Forms: Report FUTA on Form 940 (due January 31) and FICA on Form 941 (due quarterly).

Making Payroll Tax Payments

Doing these calculations is the hard part, it’s a cake walk from here. You’ll enroll in the Electronic Federal Tax Payment System (EFTPS), this is the only way to make payroll tax payments.

State and Local Payroll Tax

Employers also have the responsibility of paying state and local (city, county, etc.) payroll taxes for their employees. Like federal payroll taxes, this tax consists of portions paid by both the employer and the employee. It’s important to note that “employee-paid” simply implies that you, as the employer, deduct a specific amount from your employee’s paycheck and then submit it as part of your payroll taxes.

In addition to state payroll tax (State Unemployment Tax, or SUTA), employers are also responsible for remitting state income tax on behalf of their employees.

Payroll tax rates and rules vary by jurisdiction due to state and local payroll taxes being decided at the state and local levels. To find out more about payroll tax in your state and local area, check out the Federation of Tax Administrators’ List.

You Can Outsource Payroll Tax

Payroll tax is complex. The calculations are nit-picky, and the penalties are steep. Late payments alone can incur penalties ranging from 2% to a staggering 15% on overdue amounts.

If the thought of managing all this gives you a headache, why not consider outsourcing your payroll to a trusted partner like us at Journey Payroll & HR? We specialize in alleviating the burdens associated with payroll, from ensuring accurate and timely payments to handling complicated withholding calculations and tax obligations.

With us by your side, you can do what you do best, and we’ll do the same. Plus, you’ll have access to automatically generated pay stubs with all the necessary information whenever you need them.

When it comes time to record payroll costs in your books, rest assured that Journey Payroll & HR has got you covered.