How to Calculate Payroll Withholdings

With the exception a person who is self-employed with no employees, all businesses are required to calculate payroll withholdings for federal taxes. In most cases there are state and local taxes as well. As a businessperson, you may never need to calculate payroll withholdings yourself---it is easier to simply using computer payroll software. It's still a good idea to know how it's done. Understanding the process will help you spot potentially costly errors and better manage labor costs.

Difficulty: Moderate

Instructions

Things You'll Need:

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

1. Find each worker's gross earnings. Gross earnings are the total of hourly wages or salary plus any commissions and tips or other earned compensation. Exclude reimbursements for business expenses.

2. Compute the amount subject to federal income tax withholding. From the employee's W-4 form take the number of withholding allowances claimed and multiply by the amount for one allowance for the length of the pay period. For example, in 2009 the amount for one withholding allowance for an employee paid every two weeks was $140.38. If the employee claims two allowances, that is 2 x $140.38 or $280.76. Subtract this amount from gross earnings. Then subtract any other deductions such as tax-exempt contributions to a retirement plan. This is taxable income for federal income tax withholding.

3. Calculate federal income tax withholding. Find the tax table in IRS Publication 15, Circular E for the employee's marital status and the length of the pay period. Compute the amount of tax for each tax bracket and total the amounts. For example, if a single person paid biweekly has taxable income of $450, the tax on the first $102 is zero (using 2009 rates. From $102 to $400 the tax is 10 percent ($29.80). Take 15 percent of the amount over $400, or 0.15 x $50 ($7.50). Add $29.80 plus $7.50 to find the federal income tax to be withheld of $37.30.

4. Follow the instructions for computing state and/or local income tax withholding. Each state and local government that levies payroll taxes has its own formula, so you will need the instructions for your locality. You can order them from your state/local department of revenue or taxation.

5. Calculate Medicare and Social Security taxes. Medicare tax is 1.45 percent of gross earnings. Social Security tax is 6.20 percent of gross earnings but there is an annual cap ($106,800 in 2009). If the year-to-date earnings exceed the cap, stop withholding Social Security tax. There is no cap on the Medicare tax.

6. Calculate the employee's paycheck. Start with gross earnings and subtract each of the tax amounts. Then subtract any other amounts to be withheld, like health insurance premiums or retirement plan contributions. Finally, add any reimbursements for business expenses. Enter each amount on the pay stub and make out the paycheck.

Tips & Warnings

• Don't forget employers are also required to pay some payroll taxes in addition to the ones employees pay, including employer contributions to Social Security/Medicare and unemployment taxes. You'll find instructions for these taxes in the same government publications you use for payroll tax withholdings calculations.

References

• IRS Publication 15, Circular E
• 2009 Bi-weekly Federal Tax Tables

Resources

• Social Security Tax Information
• Buzzle.com: Payroll Tax Guidelines