How to Calculate Payroll Taxes
For better or worse, payroll costs more than the amount you pay employees each pay period. For each employee you hire, you're required to deduct payroll taxes—income, Social Security, and Medicare taxes—and match the Social Security and Medicare taxes in kind.
Fortunately, once you figure out the basics, deducting the right amount from an employee's hourly or salaried paycheck is pretty straightforward (at least, as straightforward as anything involving taxes can be). Unfortunately, the learning curve is pretty steep.
You can always opt out of the trickiest parts of calculating payroll taxes by subscribing to full-service payroll software. But if payroll software isn't in the budget right now, or if you have just one or two employees and would rather calculate taxes by hand, we have you covered. Keep reading: we explain what payroll taxes are so you can make sure you're following the tax code to a T.
Types of payroll taxes
First, let's make sure you know what you're responsible for calculating, withholding, and paying:
- Employee payroll taxes, or the amount you deduct from your employees' paychecks for federal and state income taxes, Social Security, and Medicare
- Employer payroll taxes, or the taxes your business pays based on your employees' paychecks
Employer payroll taxes generally break down into two main categories:
- FUTA (Federal Unemployment Tax Act) tax, or the amount your business contributes to federal unemployment insurance
- FICA (Federal Insurance Contributions Act) tax, or the amount your business contributes to Social Security and Medicare alongside your employees
If you own your business and don't have any employees, you'll pay a self-employment tax on your own income. Like payroll taxes, the self-employment tax includes Social Security and Medicare taxes.
How to calculate employee payroll taxes
Federal income taxes (FIT)
Before you can calculate employee payroll taxes, you need to collect your employees' W-4 tax forms.
On Form W-4, employees indicate their withholding allowances, which lets you know how much to deduct from each paycheck for federal income taxes (FIT). Employees should fill out and return these forms as soon as they're hired.
Form W-4 for the 2020 tax year looks substantially different from previous W-4 forms. Older versions of the form included a worksheet for employees to calculate a total number of allowances. Now, the worksheet asks a few simple questions about the employee's filing status, dependents, other jobs, and additional allowances. If your employees started working before 2020, they don't need to submit a new W-4 form, but employees who began work in 2020 should have filled out the new form.
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. You can find these tables 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.
When looking at the publication, scroll to the page's main contents heading to find the table you need based on which of these two methods you use:
- 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.
A word of warning: When you hop over to Publication 15-T, you'll notice that the IRS lists more than just two tables. Instead, it lists tables for manual or automated payroll calculations; for daily, weekly, biweekly, semimonthly, or monthly pay schedules; for single people, married people, or people filing as the head of household; and for employees who submitted pre-2020 W-4 forms.
It's actually not as complicated as it looks—you just need to find the right table for your employee's situation buried among the options. To do so, scroll to the main contents section of Publication 15-T. Under that heading, the tables break down by the type of method you use, when your employee filed their W-4, how often you pay your employee, and your employees' marriage status.
State income taxes
Did you make it through the maze of federal income tax calculations? Congrats—that was the hardest part, and every other calculation is much more straightforward. For starters, not all states have an individual income tax, which takes one more deduction off your plate.
If your state does have an individual income tax, you'll need to look up your state's specific tax rates and income brackets, which vary widely from sea to shining sea. A state-specific income tax calculator is your best bet for calculating the right amount to withhold.
The Federal Insurance Contributions Act requires employees and employers to contribute to Social Security and Medicare. For the 2020 tax year, employers and employees both pay 6.2% of the employee's wages toward Social Security (the total contributions must equal 12.4%). And employers and employees both pay 1.45% towards Medicare for a matched total of 2.9%.
In total, FICA taxes (from both employer and employee) should total 15.3% of each employee's paycheck.
Since FICA taxes are based on a flat rate, calculating the deduction amount (and your own matched contribution) is a cinch. Just multiply an employee's gross pay by each tax rate—that's 0.062 for Social Security and 0.0145 for Medicare—and subtract that number from the gross pay.
How to calculate employer payroll taxes
In 2020, 6.2% of an employee's paycheck should go toward Social Security. As an employer, you match that contribution out of your own wallet. The same is true of Medicare contributions, which are 1.45% of an employee's paycheck, matched by you. To see what you need to pay, multiply your employee's gross pay by the going tax rates. When you remit the employee's taxes, you'll pay your matching contribution.
Per the Federal Unemployment Tax Act, employers pay 6% on the first $7,000 each employee earns per calendar year. Employees do not pay FUTA taxes—these taxes are an employer-paid contribution to state unemployment agencies.
Does 6% feel a little steep? Good news: 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.
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How to calculate self-employment taxes
Are you a solopreneur with no employees? Alas, you still have to pay FICA taxes, including matching the employer contribution (yes, even though you are both employer and employee). Currently, the self-employed FICA tax rate is 15.3% of your net income. And like any other employee, you'll also pay state and federal income taxes. Make sure to calculate and remit those taxes quarterly to avoid any unpleasant surprises come tax season.
Methods for calculating payroll taxes
If you aren't eager to run the above calculations by hand, we can't blame you. (Hassle only begins to describe the tangled nightmare that is taxes.) Luckily, you have a few more options than just a spreadsheet and some deeply confusing IRS tax tables:
- With payroll tax calculators, you enter your employee's gross pay and allowances to calculate the total tax withholding amount. Some calculators let you enter your state to autofill the correct income tax rate for your area.
- With self-service payroll software, you still calculate and remit your employees' taxes, but the software stores your information and offers built-in tools (like payroll tax calculators) to make tax calculations a little easier.
- With full-service payroll software, the software calculates and remits payroll taxes for you.
- With an outsourced payroll company, another company handles all the ins and outs of your payroll taxes, including remitting taxes on your behalf and sending employees their W-2 forms at the end of the year.
Payroll tax FAQ
What is the payroll tax?
There actually isn't a payroll tax—instead, "payroll tax" is an umbrella term for the various types of taxes employers deduct from their employees' paychecks. Typically, payroll taxes include 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.
Do employers deduct income tax for 1099 employees?
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.
We'll be blunt: payroll taxes are hard. Really hard. But there are resources to help you minimize the chance of mistakes and send your employees home with the right amount of hard-earned cash. With the right payroll calculator or payroll software, you and the IRS can get on the same page and stay there, no matter how tax codes and percentages change in the coming years.
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