How to Manually Calculate Payroll Taxes

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Figuring payroll taxes isn't difficult, but it can be complicated because there are a minimum of seven different taxes to consider---and even more when you factor in state and local income taxes. You may never need to manually calculate payroll taxes, but it's wise to know how because you'll understand the process more thoroughly. This will help business owners spot errors and better control labor costs.

Things You'll Need

  • IRS Publication 15, Circular E
  • State/local payroll tax instructions
  • Employee W-4 forms

Instructions

  1. Add up the employee's gross wages. Gross wages consist of hourly earnings or salary for the pay period plus any tips, commissions or other earned compensation. Don't include reimbursements for business expenses. If those are to be included on a paycheck, they should be added after all taxes are calculated.

  2. Determine federal taxable income. To do this, start by multiplying the number of withholding allowances (from the employee's W-4 form) by the amount of one allowance for the length of the pay period (from the current year's IRS Publication 15, Circular E). Subtract this amount from the gross wages. Subtract any other deductible amounts such as contributions to a tax-deferred retirement plan. This is the federal taxable income.

  3. Calculate federal income tax. Federal income tax is computed on a sliding scale using the tax tables in IRS Publication 15, Circular E. For example, suppose the federal taxable income for an employee who is single and paid biweekly works out to $500. There is no tax on the first $102 (2009 tax rates). From $102 to $400 the tax rate is 10 percent ($29.80). The amount over $400 ($100 in this example) is taxed at 15 percent ($15) Add the amounts $29.80 and $15 together to find the federal income tax to be withheld ($34.80).

  4. Compute Social Security and Medicare taxes. Social Security tax is 6.2 percent of gross income, unless the year-to-date earnings are more than the annual cap (the cap changes each year, so make sure you use the current figure). Medicare tax is 1.45 percent of gross income with no cap. The employer pays a matching (equal) amount in Social Security and Medicare taxes. However, since the amounts are always equal, once you figure the employee's contribution you've figured the employer's as well.

  5. Calculate any state and local income taxes. The formulas for state or local taxes (if any) vary. Contact your state, county or city department of taxation or revenue to obtain any required forms and the instructions on how to calculate these taxes.

  6. Calculate federal unemployment (FUTA) and state unemployment (SUTA taxes). Always calculate the SUTA tax first, because you can take a credit for it against the FUTA tax. In most states SUTA is a flat percentage of employee pay up to a year-to-date earnings cap. The FUTA tax is 6.2 percent of the first $7,000 of yearly earnings. However, you may subtract SUTA contributions up to 5.4 percent of employee earnings, leaving a minimum FUTA tax of 0.8 percent.

  7. Subtract those taxes the employee pays from the gross wages. Employee-paid taxes are the federal income tax, employee Social Security and Medicare and any state/local income taxes. All other items are employer-paid taxes and may not be deducted from an employee's pay. Be sure to also deduct any contributions to retirement plans, health insurance or other items before making out the employee's paycheck, and record the amount of each tax or other deduction in the appropriate place on the pay stub.

References

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