What Are Payroll Taxes And Deductions?

how to calculate payroll tax expense

Stock options and any related gains from exercising stock options are not considered compensation for purposes of the payroll expense tax. For example, college students are exempt from paying FICA taxes on the wages they earn from an on-campus job. Exemptions also apply to some nonresident aliens, including foreign government employees and teachers. Certain religious groups may apply for an exemption from FICA taxes by filing IRS Form 4029.

Be sure to send both the taxes you withheld from your employee’s paycheck as well as the taxes that you as the employer are responsible for. Also, be sure to check whether your state imposes local taxes that are paid on top of federal and state taxes. The Federal Insurance Contributions Act taxes are Social Security and Medicare, which are required to be withheld from all employees unless otherwise exempt.

Note that calculation methods can vary depending on the employee’s total income. Those who earn more than $100,000 per year may require the IRS percentage method instead of the wage bracket method. Employees used to be able to claim allowances for children and other dependents on their Form W4, but the IRS simplified the process in 2020. Now, on Step 3 of Form W4, employees have a total credit amount for claimed dependents.

A business that qualifies as a non-profit healthcare entity may deduct the payroll expense of employees whose compensation is $150,000 to $399,999.99 from the payroll expense of the business. The employer would deduct the payroll expense of such employees on the tax return. Businesses subject to the tax will consolidate all quarterly tax filing information for 2021 and report the combined information in the 4th quarter. Starting in 2022, the payroll expense tax will be reported and paid on a quarterly basis.


The good news is that although the tax code may seem complicated, once you figure out what tax filings are required and learn how to do the math, the process is fairly straightforward. With that being said, calculating payroll taxes correctly is critical not only to your employees but also to your accountant and Uncle Sam.

How does a payroll account work?

A payroll account is a separate bank account for your business that is strictly used for payroll. Instead of lumping all your business expenses into one account, you will pay employee wages with your payroll bank account. The money going into the payroll account will only be used for payroll.

Treasury’s general fund to pay off debt, issue loans, and for other reasons. Employees fill out IRS Form W-4 to notify their employers of how much tax they want to withhold from their paycheck each pay period. This is based on their filing status, dependents, and any anticipated tax credit and deductions. The federal unemployment tax rate is 6% with an $7,000 wage base. Most employers get a credit of up to 5.4% for taxes paid to their state unemployment fund. That means that most employers pay 0.6% (less than 1%) on the first $7,000 of wages paid to each employee. Once gross payroll has been calculated, we can start looking at deductions.

If your business is taxed as an S corporation or C corporation, you’re possibly considered an employee and don’t have to worry about self-employment taxes. Social Security and Medicare taxes fund the retirement benefits U.S. workers enjoy during retirement.

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The payroll company will update their software for changes in the tax code. Accounting software is available to help you with these calculations. If you use software, make sure that the company sends you any necessary updates. As the tax law changes, the payroll tax software must be changed.

how to calculate payroll tax expense

These will be reported on the income statement in the accounting period when the wages and salaries were earned by the employee. Gross pay includes any hourly wages, tips, and bonus compensation. Apply the IRS rules to compute federal tax withholdings from gross pay. The worker provides the employer with their filing status and the number of allowances they are qualified to take. The allowances are used to calculate the amount held from gross pay. Upon hiring, each employee is required to fill out a Form W-4.

Adding Up Deductions And Withholding

In addition to income taxes, FICA requires a deduction from employees’ pay for federal social security and Medicare benefits programs. FICA taxes are withheld by the employer and are deposited along with federal income taxes in a financial institution. The federal income tax and employee contributions to Social Security and Medicare are paid by workers through deductions from wages or salary and so are not employer payroll tax expenses.

One definite way to distinguish an independent contractor from an employee is by the availability of services. An independent contractor is not tied to one company and can advertise services; an employee cannot advertise services unless they are working outside the company as an independent contractor. Some employees pay more Social Security taxes than they need to. This could happen if you switch jobs more than once and all of your earnings are taxed . Fortunately, you may be able to get a refund when you file your taxes.

The business contributes a matching amount for each tax that is not deducted from the employee’s pay. Using Worksheet 1 on page 5, we will determine how much federal income tax to withhold per pay period.

Ontario applies a health premium tax to all payrolls on a sliding scale up to $900 per year. Depending on your state and locality, you may check the map by state that is provided by the American Payroll Association. Links are provided to all tax reporting requirements based on your location. The Case for Choosing a Top Payroll Company Determining the best payroll system should always be among a business owner’s top priorities. It’s particularly important when a business owner realizes just how time-intensive and costly it can be to manage payroll in-house. Barbara Weltman is a tax and business attorney and the author of J.K. Lasser’s Tax Deductions for Small Business as well as 25 other small business books.

how to calculate payroll tax expense

So if an employee’s gross taxable wages are $1,000 for the pay period, the employee pays $62, and you would pay $62. The FICA tax rate is applied to all taxable compensation. FICA taxes include salary, wages, tips, bonuses, commissions, and taxable fringe benefits. IRS Publication 15-B has a chart of various fringe benefits that are subject to FICA and those that are exempt (see Table 2-1). Compensation subject to FICA also includes salary reduction contributions employees make to 401 or other comparable plans.

Therefore, the total cost of the employee to the employer is $480.00 in wages plus $58.80 in taxes. For help calculating anything on your own, you can calculate payroll taxes using ourbusiness calculatorsfor help. They shouldn’t be used to run payroll for your business but can help guide you when making decisions.

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Assume that a restaurant owes workers $3,000 in payroll for the last five days of March and that the next payroll date is April 5. Using the accrual method, the $3,000 wage expense posts on March 31, along with a $3,000 increase in wages payable. The SECA tax is calculated on the basis of net earnings, which is gross income minus any expenses incurred while doing business. The Social Security tax is only applied to the first $137,700 of a self-employed worker’s net pay, which results in a maximum tax of $17,075 for 2020.

According to the IRS withholding table, the business should withhold $204 from his paycheck. The IRS redesigned the W-4 in 2020 and changed the way you enter withholding, but employees you hired before then don’t need to fill out a new form. Employees should use the IRS withholding calculator to determine the right withholding amount. Business owners are not usually considered employees in their businesses, so their income bookkeeping is subject to different tax calculations. Pennsylvania businesses pay between 1.2905% and 9.9333% in SUTA on every employee’s wages until they earn $10,000 for the year. Only employers pay SUTA taxes, except in Alaska, New Jersey, and Pennsylvania, where employees chip in. Applicant Tracking Choosing the best applicant tracking system is crucial to having a smooth recruitment process that saves you time and money.

how to calculate payroll tax expense

To calculate your State Unemployment tax, multiply wages by your tax rate. Many states will limit the tax a business must pay by specifying a maximum wage amount to which tax applies. Reporting and deposit requirements can be monthly, quarterly, bi-annual or annual, depending on the amount of tax due. Keep in mind that unemployment tax is paid for by employers. In most states, just the employer pays the unemployment tax. This system, however, combines a federal unemployment tax system with a state program.

Add the regular Medicare tax rate (1.45%) to the additional Medicare tax rate (0.9%). Keep in mind that income and unemployment taxes are not technically payroll taxes. After you calculate all taxes on the gross taxable $900, add the $200 expense reimbursement. The $200 expense reimbursement increases the net wages you pay to the employee. Employers Accounting Periods and Methods are required to pay payroll taxes to the taxing jurisdiction under varying rules, in many cases within one banking day. Whatever the tax is on employee compensation, apply an equal amount to the employer obligation for the FICA tax deductions. Employees may withhold extra taxes each pay period by entering a desired amount in Step 4 of Form W-4.

Social Security And Medicare Tax

This is the amount you will deduct from your employee’s paycheck and remit along with your payroll taxes. FICA stands for “Federal Insurance Contributions Act.” It’s a mandatory payroll tax deduction used to pay for programs like Social Security and Medicare . Take a look at the following examples to understand how to calculate FICA and SECA payroll taxes.

  • Planning your finances goes beyond just taxes.Find a local financial advisor today.
  • FICA was initially created in 1935 to pay for Social Security benefits to retirees.
  • Typically, if you do not receive a salary like your employees, you must pay self-employment taxes.
  • You are required to begin withholding Additional Medicare Tax in the pay period in which it pays wages and compensation in excess of the threshold amount to an employee.
  • When you enter the information from your employee’s W-4 in your payroll software, it consults the IRS federal tax withholding tables to determine your employee’s withholding.
  • Processing payroll requires a company to complete several steps and calculate withholdings for employees.

Of the 15.3% total SECA tax, 12.4% goes to Social Security and 2.9% goes to Medicare tax. After you earn $142,800, you do not need to pay the Social Security tax portion.

You will then use your state’s tax rates to determine how much state income tax you owe. Certain payroll taxes are deductible to a business paying them on behalf of their employees, but they are not deductible by the employees themselves.

The control you have over a worker determines if the worker is an employee or an independent contractor. The guidelines consider how much control you have over what the payroll accounting worker does, who provides tools and supplies, and if you have a written contract. If you have a lot of control over a worker, you should classify them as an employee.

You also will pay each type of tax through a different system. Consider hiring a payroll company to help you stay on top of this process.

Author: Craig W. Smalley, E.A.