How to Figure Payroll Withholdings

Calculating payroll is one of the essential accounting tasks any business must perform on a regular basis. The process used to figure payroll withholdings has not changed much in decades, although even very small businesses now use computers to do the actual calculations. It remains important to understand the individual steps used to figure payroll withholdings, both to monitor and control labor costs and to catch potentially costly errors. Always review a payroll before distributing checks. It takes only a single missed keystroke to convert a $400 paycheck into a $4,000 mistake.

Things You'll Need

  • Calculator
  • W-4 forms
  • IRS Publication15
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    • 1

      Total the employee's gross wages for the pay period. Gross wages include regular hourly pay or salary, overtime, tips, commissions, and other taxable compensation. Do not include reimbursements (travel expenses, for example), even if they are to be added into the paycheck. Add them after all payroll withholdings have been calculated and deducted.

    • 2

      Use the employee's W-4 form to calculate the number and amount of withholding exemptions. If an employee has not submitted a W-4, assume zero withholding allowances. The total withholding allowance amount is the number of withholding allowances multiplied by the amount for one allowance for the length of the pay period. For example, in 2008, say the amount for an employee paid weekly was $67.61. If an employee claimed two withholding allowances, this was 2 times $67.61, or $135.22. Refer to the current year's version of IRS Publication 15, Circular E for the amounts of withholding allowances (see Resources).

    • 3

      Calculate taxable income for federal income taxes. Subtract the total withholding allowance from the gross pay. Then subtract any other deductions, such as contributions to a tax--deferred retirement account. This gives you the taxable income for figuring federal income tax to be withheld. For example, if an employee paid weekly with two allowances (from Step 2) makes $600 and contributes $50 to a retirement account, the taxable income is $600 minus ($135.22 + $50.00), or $414.78.

    • 4

      Figure federal income tax to be withheld. Federal income tax is based on a series of tax brackets, with higher percentages of tax withheld as income increases. Use the tables in Publication 15, Circular E to calculate the amount of federal income tax to withhold. For instance, if the employee's weekly taxable income was $414.78 (from Step 3), then the federal income tax works out to $0 for the first $51, 10 percent of the amount from $51 to $198 ($14.70), and 15 percent of the amount over $198 ($32.52), for a total of $47.22. Finally, add any additional amount the employee has asked to be withheld on her W-4 form.

    • 5

      Calculate Social Security and Medicare tax to be withheld. Start with gross wages (there are no withholding exemptions for Social Security/Medicare). The Social Security tax is 6.2 percent of gross wages for the first $102,000 earned (2008 limit). Once the limit is reached, don't deduct any more Social security tax. There is no limit for Medicare tax, which is 1.45 percent of gross income.

    • 6

      Figure payroll withholdings for state income taxes and other items, such as contributions to retirement plans or health insurance. The formula for state income tax varies from state to state, and you will need the instructions from your state's Department of Taxation (or Revenue). Once you have figured these items, subtract each withholding item from the gross pay. Add in any non-taxable reimbursements to find the net pay (the amount of the employee's paycheck). In addition to payroll withholdings, a business is responsible for several items based on the employee's wages but that are paid by the employer. These include matching taxes for Social Security/Medicare, unemployment (FUTA and SUTA) taxes, and employer contributions for health insurance and profit-sharing or pension plans.

Tips & Warnings

  • In addition to payroll withholdings, a business is responsible for several items that are based on the employee's wages but that are paid by the employer. These include matching taxes for Social Security/Medicare, unemployment (FUTA and SUTA) taxes, and employer contributions for health insurance and profit-sharing or pension plans.

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