How to Determine Payroll Taxes
Payroll is the compensation you owe your employees for their work in your business. Payroll is calculated based on the gross pay minus all taxes and deductions that must be paid. One of the many duties an employer has is calculating payroll taxes for their employees and withholding them before delivering them their salary.
This may sound simple in theory but can be complicated in practice. Payroll is different across all states. Some states, like California, impose a state income tax. Others, such as Florida and Texas, do not. In addition, some cities have unique tax regimens, which you should consider when doing your calculations.
To help you out, we have prepared this brief guide on calculating payroll taxes and keeping up with your duties as an employer.
What Is Gross Income?
Gross income is the amount your employees earn at your business before any deductions and taxes. If, for example, you agreed that your employee’s salary is $55,000, that is their gross income.
Alternatively, if your employees work for your business on an hourly basis, you multiply the hours they worked by their hourly compensation to find their gross income. For instance, if your employee worked for 100 hours at $18 an hour, their gross income is $1800.
As a business, you can decide how often you pay your employees. This is called payroll frequency. While you have several choices, the most common ones are the following:
- Monthly: you pay your employees once a month, usually at the end of the worked month or at the start of the next one.
- Twice a month: you pay your employees twice a month, usually in the middle and at the end of the worked month.
- Bi-weekly: you pay your employees every two weeks.
- Weekly: you pay your employees every week.
In the above example of a $55,000 annual salary and a monthly payroll frequency, your employee will make $4,583.33 monthly.
If your employee worked hourly, was paid twice a month, and worked 100 hours that month, you would divide $1,800 by two and pay them $900 for the payroll cycle.
Mandatory Payroll Taxes and Deductions
Once you know how often you will pay your employees, it is time to deduct taxes and all other necessary deductions from the gross income. What is left is the employee’s net income: that’s the income they take home.
Pre-Tax Deductions and Reimbursements
Some deductions are non-taxable. That means they are deducted from the gross income and are not subject to tax. Such non-taxable deductions (or pre-tax deductions) include Health Savings Accounts (HSA), some 401(k) plans, dependent care assistance, some life insurance plans, and a few other benefits.
Expense reimbursements are also non-taxable. If your employee attended a conference for your business and paid for accommodation, their refund is non-taxable.
When you deduct pre-tax deductions and reimbursements, the taxable income is lower, and your employee pays less in FICA tax and income tax. This also works to your benefit since you are asked, as an employer, to match the FICA contributions your employees pay.
FICA Tax
Once you have removed pre-tax deductions and reimbursements from your employee’s taxable income, it is time to calculate taxes and payments, starting with the Federal Insurance Contributions Act (FICA) tax.
FICA tax is the amount the employee pays for Social Security and Medicare. Social security tax is 6.2%, and Medicare tax is 1.45%. Together, they add up to 7.65%, or the total FICA tax.
As an employer, you must match these contributions. In our example, a monthly salary of $4,583.33 without pre-tax deductions will result in $350.62 in FICA tax.
As an employer, you must pay an equal amount to the IRS. Therefore, your payment to the IRS will be $701.25, half from your employee’s paycheck and half from your business account.
Federal Income Tax
You must also deduct federal income tax from gross income. Federal income tax depends on salary, marital status, and other criteria. The first bracket stands at 10% and reaches 37% for income above $539,900 for single filers and $647,850 for married individuals filing joint returns.
As an employer, you are not required to match your employees’ federal income tax contributions.
State Income Tax
Not all states charge state. California, for example, charges a state income tax that depends on the income level and starts at 1% and goes up to 12.3% for higher incomes. Most states, including Hawaii, New Jersey, New York, Maine, Massachusetts, Connecticut, Iowa, Minnesota, and Colorado, charge a state income tax. Some of them have a flat rate, while others have a fluctuating one.
Other states, including Texas, Alaska, Nevada, Florida, Washington, Wyoming, South Dakota, Tennessee, and New Hampshire, do not charge state income taxes.
Local Income Tax
In addition to the state tax, some states charge a local income tax for people living in a specific area or city. Colorado, Oregon, Ohio, West Virginia, Indiana, Alabama, and Michigan are examples of states that charge local income tax for some localities.
Federal and State Unemployment Tax
Employers must pay a Federal and State Unemployment Tax, or FUTA. This is part of the payroll, although it is not deducted from your employee’s wages. The amount you pay as unemployment tax is calculated based on your employees’ wage levels.
The current FUTA rate is 6% and applies to the first $7,000 you pay your employees annually. It should be noted that there are some credit reductions to the FUTA rate depending on your state.
Voluntary Deductions
Voluntary deductions are subtracted after mandatory taxes and contributions have been calculated.
Voluntary deductions include Roth 401(k), whereby you pay the tax now and enjoy tax-free withdrawal when you withdraw from your retirement savings. Voluntary deductions also include long-term disability insurance plans, life insurance plans, union dues, and some types of medical and dental insurance plans.
Voluntary deductions encompass wage garnishments. Garnishments are court-mandated payments for past debts, unpaid loans and taxes, and overdue child support. Garnishments have an upper ceiling of 25% of disposable income, as set by federal law.
Calculating Tax as Self-Employed
If you are self-employed, you pay the total FICA tax since you have no employer contribution. Thus, you pay 12.4% for Social Security and 2.9% for Medicare. This is calculated on net earnings. Net earnings are calculated as gross income minus all business expenses.
You Have Calculated the Payroll
Once you have included pre-tax deductions, FICA, federal and state tax, and other deductions, you end up with the net income your employees get paid. You can pay them either by crediting their account or by check.
Why Hire a Bookkeeping Company for Your Payroll Tax Calculations?
If the above sounds complicated, that’s because it is. Determining payroll taxes on your own is complex and risky: you may miss a deadline or waste an opportunity for decreased taxes, both of which can be costly mistakes.
Software Packages Require Personnel
One possible solution is to use a software package. While several software packages calculate your payroll tax payments, taxes, and deductions, it is easy to get confused by federal, state, and other compliance requirements.
You also need someone from your HR or accounting department to input all information and data—which can be time-consuming. There are many deadlines, and if you are short-staffed or are going through a hectic time, you could risk missing a deadline and paying a hefty fine, not to mention disgruntled employees.
Payroll Calculations Are Time-Consuming
Besides the risks of using a software package alone, keeping track of employees’ time, vacation time, and other requirements can be time-consuming and stressful, especially if you are not a professional bookkeeper.
Reports on Demand from Your Bookkeeping Service
A professional bookkeeping service can both handle all your payroll needs and deliver reports on demand for your HR department or if you want to have a precise picture of your payroll expenses.
Hiring a bookkeeper for your payroll taxes is thus the most cost-effective and safest option for your business. It gives you peace of mind and the certainty that a professional is on top of all your payroll affairs.
Let Remote Quality Bookkeeping Manage Your Payroll
Hiring a bookkeeping company like Remote Quality Bookkeeping makes payroll a breeze. Even better, we take care of invoices, bills, payroll, and reports, thus letting you work on what matters most: growing your business.
As a bonus, tax season is much easier when the bookkeeper does all the work throughout the year. You can easily access the information you need to deduct business expenses or apply for certain tax breaks for your company.
Schedule a free demonstration to see why Remote Quality Bookkeeping offers you the easiest and most straightforward way to keep up to date with your books and payroll taxes. Focus on your core strengths by trusting us to work on ours!
