How to Calculate Payroll Taxes
The term "payroll tax" is a bit misleading because it isn't just one tax. It's an assortment of taxes paid by employees and employers. As the owner of a small business, it's your responsibility to withhold certain payroll taxes and remit others every pay period.
This guide will explain the different payroll taxes and teach you how to calculate each type of payroll tax. You don't have to go at it alone, though. Skynova's accounting software is specially made for small businesses and can help you keep accurate records, so managing payroll taxes is a breeze.
What Are Payroll Taxes?
Some payroll taxes are paid by the employer, while others are paid jointly by the employer and employee. State and federal income taxes are paid solely by the employee.
Taxes typically paid by the employer include:
- State Unemployment Tax Act (SUTA): This tax is used to pay unemployment insurance benefits to workers who've lost employment through no fault of their own.
- Federal Unemployment Tax Act (FUTA): FUTA taxes make up a federal fund that states can borrow from to pay unemployment in down economic times.
- Workers' Compensation: This state tax benefits employees who've been hurt while working and can no longer complete their duties.
Taxes typically paid by both the employee and employer include:
- State Disability Insurance (SDI): This tax is used by a state to fund insurance benefits and sometimes wage replacement for disabled workers. It can be paid by employers, withheld from employees, or a mix of the two.
- Federal Insurance Contributions Act (FICA): This tax is used to fund Social Security benefits for people who're retiring and Medicare benefits for people who need insurance.
Important Payroll Tax Forms
A W-4 is an employee's withholding certificate for federal income tax (FIT). It indicates whether a person is married or single, how many dependents they have, and their number of allowances. Some states also have their own W-4.
A direct deposit authorization form lets an employer or accounting department send money directly to an employee's bank account using an American Bankers Association (ABA) routing and account number. Employers will often ask for a voided check to make sure the account is legitimate.
Form I-9 verifies an employee's authorization to work in the United States. It also identifies them as a U.S. citizen, national (noncitizens from U.S. territories), lawful permanent resident (immigrant green card holder), or an alien authorized to work. To fill this form out, an employee will need two forms of identification.
What Is the Percentage of Federal Taxes Taken Out of a Paycheck?
Federal payroll taxes are based on an employee's gross income. Except for the Medicare portion of FICA taxes, federal payroll taxes have wage bases. A wage base is the largest amount of income that the government can legally charge payroll taxes. With wage bases, higher earners pay a smaller portion of their income to the government. That's why payroll taxes are known as regressive taxes.
Social Security Tax
Social Security taxes make up half of FICA taxes. The Social Security tax due to the government for each employee is 12.4% of the employee's gross income. However, the employee and employer pay half (6.2%) of the total amount of the Social Security tax.
If an employee makes $40,000 in gross income, the Social Security tax due would be $4,960. The employer and the employee would each pay $2,480. The current wage base for Social Security tax is $137,700, but that amount can change.
Medicare taxes make up the other half of FICA taxes. The government charges 2.9% of an employee's gross income in Medicare taxes. Once again, the employee pays half (1.45%). Medicare taxes don't have a wage base limit. High earners pay a larger portion of their income than those who make less. Employees pay an additional Medicare tax of 0.9% on any income after a certain amount based on marital status.
- Married and filing jointly: $250,000/year
- Married and filing separately: $125,000/year
- Single or widowed: $200,000/year
If a single worker makes $220,000 a year, the amount of Medicare tax is $6,270 ($5,800 on the first $200,000 and $470 on the last $20,000). The employer pays $2,900 (1.45% of the first $200,000). The employee pays $3,370 (1.45% on the first $200,000 and 2.35% on the remaining $20,000). On money after $200,000, the employee pays the base rate of 1.45% plus an additional 0.9% (2.35% total). The employer doesn't have to match the additional tax.
Federal Unemployment Tax Act (FUTA)
FUTA taxes charge 6% on the first $7,000 of an employee's gross income every year. FUTA taxes are only paid by employers. The FUTA credit is 5.4%, which means that employers only have to pay 0.6% of an employee's income in FUTA (if they qualify).
Credit reduction states have not fully paid back unemployment loans from the federal government. These states have their FUTA credit reduced until their loan is repaid. Credit reduction states in the United States include:
- New York
- West Virginia
Do Sole Proprietors Need to Pay Payroll Taxes
Sole proprietors (people who own non-incorporated, one-person businesses) don't have to pay FUTA or SUTA taxes because they have no employees. But these small business owners do have to pay FICA or, in their case, Self-Employment Contributions Act (SECA) taxes.
They are on the hook for the full portion (15.3%) of FICA taxes on 92.35% of their net (after expenses) earnings. If the owner of a sole proprietorship made $100,000 in a year after expenses, they would be on the hook for $14,129.55in self-employment taxes. However, they can deduct the employer portion of their SECA taxes, which would normally be paid by an employer, on their tax return.
(100,000 * .9235) = $92,350 Taxable Income
(92,350 * .153) = $14,129.55 SECA Taxes
How Deductions Work for Payroll Taxes
Employers can legally deduct the payroll taxes they pay. They can deduct half of the total FICA taxes paid for each employee (in normal circumstances) and the full amount of FUTA taxes paid for each employee.
On the other hand, employees cannot deduct the payroll taxes they pay. However, there are certain types of income that aren't susceptible to payroll taxes. These can include worker's compensation and income for a disabled worker.
State vs. Federal Income Tax
The higher a person's adjusted gross income (AGI) is, the more they'll pay in federal income taxes (FIT). There are seven tax brackets, ranging from a 10% tax rate for people making up to $9,875 a year to 37% for people earning over $518,400 a year. The federal income tax is known as a progressive tax because tax rates raise as a worker's income does.
Employers can view the wage bracket method tables in IRS Publication 15-T to figure out how much of an employee's income to withhold for FIT. If a worker earns over a certain amount, though ($100,000 in 2020), the wage bracket method won't work, and the employer will have to use the percentage method tables. You'll need the general information on an employee's W-4 for each method.
While some states have a progressive model for income taxes, others only require a flat rate. Others still don't require any at all. States with no income tax requirements are:
- South Dakota
- New Hampshire (Currently still charges tax on dividends and interest)
- Tennessee (Currently still charges tax on dividends and interest)
Calculate Employee Payroll Tax
Now, we'll go over how to calculate payroll taxes. Because there are so many payroll tax situations, putting it together can be difficult. It might even be wise to hire a professional. When it comes to filing payroll taxes, miscalculations can be costly.
Still, you might be able to calculate your own taxes if your situation isn't too complex. Even if it is, knowing how to figure these taxes out will at least give you an estimate of how much you'll owe.
Determine an Employee's Gross Pay
To find the gross wage of an hourly employee, multiply their hourly rate by their hours worked for the year. Then, add additional income for any overtime they may have worked. Divide that number by the total number of pay periods for the year to get their gross income per paycheck.
To find the gross pay of a salaried employee, divide their annual salary by the total number of pay periods for the year. Most businesses pay biweekly, but if your company issues paychecks monthly, divide the annual earnings by 12.
Calculate Employee Tax Withholdings
FICA taxes make up 15.3% of an employee's wages. You'll have to withhold half (7.65%). This rate can change, but it has remained the same from 2019 to 2020. It will likely be the same in 2021 as well because of the COVID-19 pandemic.
The percentage withholding for highly paid employees can be more complex. Employers will only have to withhold 6.2% of Social Security taxes for up to the wage base ($137,700) for employee income. Employers will also withhold an extra 0.9% in addition to 1.45% for Medicare for employee wages over a certain amount (based on the employee filing status).
With FICA taxes, there are exemptions for certain types of income for the disabled and investments.
You'll have to consider state and federal withholdings and tax deductions for your employee's paycheck. IRS Publication 15-T has information worksheets for figuring out how much FIT is due based on an employee's W-4. States have their own income tax rates. Do your research to know how much income tax withholding your state requires.
Additional withholdings and employee deductions can be for things like health insurance, retirement plans, and employee stock. These deductions are usually voluntary.
Account for Reimbursements
If an employee spends their own money on necessary work expenses, you might have a policy to reimburse them for the cost. Often, the reimbursement will be included in the employee's paycheck and added to their net pay.
It's important that reimbursements are accounted for so that they don't add to an employee's taxable income. If they do, the employee and employer could overpay taxes.
Add It All Up
When you add it together, you'll have an accurate picture of payroll taxes. As a business owner, you are required to keep records of payroll taxes and any other taxes that your business pays.
Manage Your Tax Forms and Accounting With Skynova
If you're not a bookkeeper by trade, it can be frustrating to run payroll. You want to spend time on your business, not in an office crunching numbers for tax payments. Skynova has accounting software that can make managing federal, state, and local income taxes and payroll taxes a breeze.
We also have a variety of professional-looking, quality templates that can help your business run better. If you've been making your own business documents, you'll be amazed at the time you save. Take a look at how our cloud-based software can help you create, send, and get approval for business documents at a rapid pace. Let us help you take the stress out of payroll.