How to Calculate Payroll Taxes for Small Businesses


The federal government, along with most state and some local governments, levies payroll taxes that businesses must calculate, collect and remit to the appropriate government agency. It’s not hard to calculate payroll taxes for a small business, but it is complicated. There are several taxes, and each is figured differently. Payroll taxes fall into two categories: those that are deducted from employee paychecks and those that the employer must pay. In addition, other items that are deducted, such as contributions to a 401(k) retirement plan, may affect the calculation of payroll taxes for small business.

Things You'll Need

  • IRS Publication 15 (Circular E)
  • Employee W-4 forms
  • State and/or local payroll tax instructions

Find the employee’s total compensation, or gross pay. Compensation includes wages or salary for the pay period, tips, commissions and any other taxable compensation. Do not include reimbursements for any business expenses, as these are not taxable and should be added to a paycheck only after all taxes and other deductions are calculated.

Calculate taxable income for federal income tax. For this, you start with the number of claimed withholding allowances on the employee’s W-4 form. Multiply the number of allowances by the amount of one allowance for the pay period (from the current IRS Publication 15, Circular E). Subtract this amount along with any other credits or tax exempt items (such as child care credits or contributions to tax-deferred retirement plans). For example, one allowance in 2009 for an employee paid biweekly was $140.38. If the employee earned $900 and claimed two allowances, you would subtract $140.38 times two ($280.76) from $900 for a federal taxable income of $619.24.

Figure the federal income tax to be withheld. Federal income tax is based on a progression of tax brackets. Find the appropriate tax table in Publication 15 for the employee’s marital status and the length of the pay period, and calculate the tax to be withheld. If the employee has a federal taxable income of $619.24 (the example from Step 2) he/she will be in the 15 percent tax bracket. You would deduct $29.80 plus 15 percent of the amount over $400 (15 percent of $219.24), which is $32.89. The total federal income tax to be withheld is $62.69 (from 2009 tables).

Calculate Social Security and Medicare taxes. Social Security tax is 6.2 percent of the gross wages up to an annual earnings cap. If this cap is reached, no further Social Security tax is withheld. The Medicare tax is 1.45 percent of all gross wages with no earnings cap. Employers pay a matching amount in Social Security/Medicare. Once you’ve calculated the tax to be deducted from an employee’s paycheck, you also have the amount owed by the employer.

Follow state and/or local guidelines for calculating payroll taxes for small business. The rules for state and local income tax computation vary, so contact your state/local department of taxation or revenue to get the necessary forms and instructions.

Calculate federal (FUTA) and state (SUTA) unemployment taxes. These are employer-paid taxes levied on the first $7000 each employee is paid every year. There is a tax credit on FUTA based on state unemployment tax paid, so SUTA should be figured first, following the instructions from your state Department of Revenue. The FUTA (federal) tax rate is 6.2 percent of gross wages minus the amount of SUTA tax paid up to 5.4 percent. For example, for an employee paid $500, the SUTA tax is 5.4 percent ($27). The base FUTA rate is 6.2 percent of $500, or $31. Subtract the SUTA amount of $27 from $31, leaving a FUTA tax due of $4. The maximum SUTA credit that may be taken on the FUTA tax is 5.4 percent, so an employer must always pay a minimum FUTA tax of 0.8 percent.

Tips & Warnings

  • Congress sets federal payroll tax rates and occasionally changes them during the year, as they did in 2009. Keep up with new developments in tax laws. When this happens, the IRS will either issue an updated Publication 15 or, as in 2009, a supplementary set of tax tables (see the link below to the 2009 supplement as an example).

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