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How to Calculate Payroll Taxes
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If you just hired a new employee, you need to learn how to calculate and pay payroll taxes, which include income, Social Security, and Medicare taxes. You're also responsible for matching each employee's Social Security and Medicare tax payments.
Payroll and accounting software can calculate payroll taxes for you, and full-service payroll software also deducts taxes automatically and remits them to the government on your behalf. But whether you're using a payroll service or running payroll by hand, it pays to understand the ins and outs of payroll taxes. We'll dive in below.
What is the payroll tax?
"The payroll tax" is an umbrella term many people use to refer to taxes business owners must pay once they've hired employees.
First, there are certain taxes you need to calculate and withhold from each employee's paycheck, including:
- Federal income taxes
- State and local income taxes (if applicable in your area)
- Social Security and Medicare taxes
You must deduct these taxes from employee paychecks, then remit them to the appropriate government agency on the correct tax-filing schedule. Additionally, business owners pay an employer portion of certain payroll taxes, specifically the Social Security and Medicare tax.
Payroll tax software like QuickBooks Payroll is the best way to track your payroll taxes, as is working with an accountant to make sure you fully understand your business's tax obligations.
How to collect employee tax information
When you hire an employee, they'll fill out a W-4 tax form and submit it to you. This particular IRS publication is also called the Employee's Withholding Certificate. It lists the employee's tax filing status, dependents, additional income, and other tax allowances. You'll use this information to withhold the tax amount requested by the employee.
Your state might require employees to fill out an additional tax form to withhold state income taxes. Other states simply use the information on form W-4 to withhold state taxes, while other states lack an income tax altogether. Business tax software, payroll software, and tax professionals can all help you understand more about your state and local tax obligations.
Federal, state, and local income taxes
Most American employees are required to pay a federal income tax on their wages earned. Federal taxation in the United States is progressive, meaning of taxation increases with a person's income.
As an employer, you're responsible for correctly calculating your employee's gross pay, then using the information on your employee's IRS Form W-4 to withhold taxes at the right federal tax rate for your employee's income.
State income taxes
Currently, eight states lack a state income tax, including Alaska, Texas, Florida, Washington, Nevada, Wyoming, South Dakota, and Tennessee.
All other states have an income tax that you, as an employer, are required to withhold and remit. If you're using a payroll calculator to draw up employee paychecks, you can simply select the correct state from a drop-down menu to get the right tax withholding calculation.
Local income taxes
Depending on where you and your employees live and work, you might also need to calculate and deduct local taxes, or an additional tax imposed at the county, city, town, or municipality level.
If your state doesn't impose a state income tax, it won't impose a local income tax. Your local tax agency can give you the best information on which local income taxes you're required to withhold for employees, if any.
FICA (Medicare and Social Security) taxes
Along with federal income taxes, employees and employers are required to contribute a certain amount of money to the federal Social Security and Medicare programs. You'll also see these taxes referred to as FICA taxes (the Federal Insurance Contributions Act, or FICA, started the requirement for employees and employers to contribute to Social Security and Medicare).
The FICA tax rate is 15.3%, but the employee only pays half that amount. The employer pays the other half in a 1:1 match.
This means 7.65% of each employee's paycheck goes toward the Medicare and Social Security tax, and you pay the matching 7.65% yourself.
Are you a solopreneur with no employees? You still have to pay the FICA tax, but since you're your own boss, you need to pay both the employee and employee portions—so the full 15.3%—of the Social Security and Medicare tax.
Employees who make more than $200,000 a year pay an additional Medicare tax of 0.09%, which employers don't need to match. Learn more about the Additional Medicare Tax on the IRS's website.
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Per the Federal Unemployment Tax Act, employers pay 6% on the first $7,000 each employee earns per calendar year. Most states offer a 5.4% tax credit, which means you'll pay only 0.6% and the state covers the rest. However, there are few exceptions, and you'll likely need to file an additional IRS form to claim a FUTA credit deduction in your state.
Employees do not pay FUTA taxes—these taxes are an employer-paid contribution to state unemployment agencies.
Unlike the FICA tax, you don't need to pay the FUTA tax if you're self-employed.
How to calculate payroll taxes
Income tax calculation
Once you have your employees' W-4s, you can calculate taxes using either the wage bracket method or the percentage method.
Both methods require you to use the IRS's income tax withholding tables, which you can find in IRS Publication 15-T. In this publication, the IRS provides a step-by-step worksheet for each method to help you calculate withholding using the tables and your employees' W-4s:
- Wage bracket method. You'll use the federal income tax tables to find the wage range of your employees' earnings. Both the range and allowances listed on the W-4 form let you know how much to deduct per pay period. However, the IRS only lists wage brackets up to $100,000. If your employees make more than that, you'll have to use the percentage method instead.
- Percentage method. You'll still use the federal income tax tables to find the wage range your employees' salaries fall under. However, the worksheet will show you both a percentage and flat dollar amount that you'll add together for the deduction amount.
FICA (Medicare and Social Security) tax calculation
Thankfully, FICA taxes are nowhere near as hard to calculate as federal income taxes. They're charged at a flat rate of 15.3% (7.25% paid by the employee and 7.25% paid by the employer).
Main payroll tax calculation methods
Even if you're going to rely on a third party like an accountant or use payroll software to handle the bulk of your payroll taxes, it's helpful to know the basics of employee tax calculations (which is why we'll run through them quickly below). Bear in mind, though, that taxes are complicated, especially if you aren't a financial professional.
Instead, the easiest way to calculate payroll taxes is to turn them over to a financial expert like an accountant. Alternatively, since hiring outside help can be expensive, payroll software (including free payroll software) is a solid middle-of-the-road option.
For instance, if you use full-service payroll software, the software will calculate the correct tax withholding amount automatically once you enter a new hire's W-4 information and pay data. Self-service software costs a little less than full-service payroll, but it still calculates employee gross pay and tax withholding amounts. However, it won't remit the taxes for you (meaning it won't send the taxes to the IRS on your behalf).
If you're calculating payroll by hand with a payroll calculator and spreadsheet template, just make sure you enter your employee's information correctly. The calculator or payroll template will do the tax calculations for you. Still, you're liable for any mistakes in your employee's paycheck and tax amounts, so make sure you double- and triple-check the financial data you enter and keep top-notch financial records.
It's hard to learn how to calculate payroll taxes entirely by hand, which is why we recommend working with an accountant or using payroll software instead. A little help makes it much easier to calculate your employees' gross pay, deduct taxes, and send them to the right agency at the right time each year.
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Payroll tax FAQ
"Payroll tax" is an umbrella term for the taxes employers deduct from their employees' paychecks, including federal and state income taxes, Social Security tax, and Medicare tax. Payroll taxes can also refer to the matched contributions employers make on some employee payroll tax contributions, specifically the Social Security tax and Medicare tax.
No. Employers withhold and remit taxes for W-2 employees only, meaning salaried or hourly employees who submit a W-4 form upon being hired. Contractors, freelancers, and other 1099 employees file their own taxes—you're not responsible for payroll tax withholding for 1099 employees.