How to Calculate Payroll Taxes For Employees

How to Calculate Payroll Taxes For Employees

Did you know that tax evasion is a criminal offense? Payroll tax evasion comes with harsh penalties such as a $500,000 fine and up to 5 years in prison. In addition to all this, they’ll still expect you to pay the unpaid tax to the IRS.

We’ll help you avoid these unnecessary misfortunes by telling you everything you need to know how to calculate payroll taxes for employees.

Payroll taxes must be paid from the moment you first hire your employee- Right from the first payment. Payroll taxes refer to all kinds of taxes paid on wages and salaries.

You also have to note that payroll tax is a double-edged sword. It’s supposed to be paid by both employer and employee. Asides from paying your taxes, it’s your responsibility as the employer to withhold taxes on your employees’ wages and salaries and pay them to the IRS on their behalf.


Types of Payroll Taxes

Before we get started on the calculations, it’s important that we first summarize the types of payroll taxes and the people responsible for paying them- This to avoid mistakes commonly made by employers who are new to payroll taxes.

1. Payroll taxes paid by both the employer and employee

Federal Insurance Contributions Act Tax (commonly referred to as “FICA Tax”): This tax covers social security and Medicare. Broken down, it’s 12.4% for social security and 2.9% for Medicare. FICA tax is equally split between the employer and employees- This means you have to pay 6.2% and 1.45% of your profits and withhold the same from each of your employees’ salaries.

Payroll taxes paid by both the employer and employee - How to Calculate Payroll Taxes For Employees

2. Payroll taxes paid by employers only

Federal Unemployment Tax Act (commonly referred to as “FUTA Tax”): This tax covers unemployment insurance. You’re supposed to pay 6.0%. However, there is 5.4% credit paid for in most states meaning that employers only pay 0.6%.

Payroll taxes paid by employers only - How to Calculate Payroll Taxes For Employees

Note: FUTA Tax is paid on the first $7000 wages of each employee- That is $42 for each employee.

3. Payroll taxes paid by employees only

Employees don’t pay these taxes. Your responsibility is to calculate and withhold them from your employees’ wages and salaries.

Payroll taxes by employees only - How to Calculate Payroll Taxes For Employees
  • Federal income taxes
  • State incomes taxes

Methods Used to Calculate Employee Federal Income Tax

Federal income taxes are paid to the federal, state, and local tax authorities quarterly.

Methods used to calculate employee federal income tax - How to Calculate Payroll Taxes For Employees
Blank W-4 form and a pen. Tax season

Below are some the things you must have to calculate federal income tax:

Use these methods to calculate federal income tax:

  • The Wage-bracket method: It’s the simplest and commonly used method. It involves comparing your employees’ wages to the IRS tax withholding tables to determine the amount to withhold as federal tax.
  • The Percentage method: It’s slightly more complex than the wage bracket method. Unless you’re a professional, we’d advise you against this method.

Payroll Tax Changes as of 2020

2020 has come with significant payroll tax changes that greatly affect how employers calculate federal income tax. It’s important to know the changes made and how they affect payroll tax.

1. New W-4 forms

As of Jan 1st, 2020, the new version of the IRS W-4 form was put to full effect.

New W4 forms - How to Calculate Payroll Taxes For Employees

The new 2020 IRS W-4 forms have eliminated withholding allowances- This means that employees are no longer able to claim withholding allowances on their wages and salaries.

Withholding allowances are claims made by employees to help reduce the federal income tax that is supposed to be withheld from their salaries and wages. It’s simple. The more claims an employee makes, the lesser the federal income tax you’ll withhold from his/her paycheck.

To whom is the new 2020 IRS W-4 form applicable? All employees hired and who’ll receive their first paycheck in 2020 and later.

Note: All your other employees hired in 2019 and earlier can continue using the old W-4 form. Therefore, they’re still able to claim withholding allowances.

2. Changes in the IRS federal income tax tables

The elimination of withholding allowances in the new W-4 forms had a ripple effect that affected the IRS federal income tax tables.

Changes in the IRS federal income tax tables - How to Calculate Payroll Taxes For Employees

The major changes were:

  • The removal of “withholding allowance” columns.
  • Tax brackets adjustments.

Read on, and you’ll see examples of how these changes affect the calculation of payroll taxes for employees.


Examples of Payroll Tax Calculations

Step 1: Calculating federal income tax using the wage bracket method

a. For employees hired before 2020 using the old W-4 form

Let’s say you have an employee earning $2500 bi-weekly (his name is Peter). Peter was hired and started receiving his first paycheck in August of 2019- This means he filled the old W-4 form and can, therefore, claim withholding allowances.

For employees hired before 2020 using the old W4 form - How to Calculate Payroll Taxes For Employees

In the form, he stated that he has a working spouse, doesn’t claim dependents, and claims 1 allowance.

To find the amount you need to withhold, go to the IRS tax tables publication 15-T.

Next, go to “Wage Bracket Method Tables for Manual Payroll Systems with Forms W-4 From 2019 or earlier”. Scroll down and look for his wage bracket (in this case, $2,495- $2,525 for married persons and claiming 1 allowance). The amount to withhold for federal tax is $204.

b. For employees hired in 2020 and beyond using the new W-4 form

We’re going to use the same example. However, you need to remember one thing- The new W-4 forms eliminated withdrawing allowances.

For employees hired in 2020 and beyond using the new W4 form - How to Calculate Payroll Taxes For Employees

To find the amount you need to withhold, go to the IRS tax tables.

Next, go to “Wage Bracket Method Tables for Manual Payroll Systems with Forms W-4 From 2020 or later”. Carefully follow the instructions as per how the employee filled his W-4 form (figure out if he filled jointly, head of the house, or filled separately). Find his age bracket and determine the amount to withhold.

Step 2: Calculating FICA Tax

We’re still going to use Peter’s $2,500 bi-weekly salary.

Calculating FICA tax - How to Calculate Payroll Taxes For Employees

Remember, to calculate FICA tax, you have to withhold Social security and Medicare Tax.

For social security, you have to withhold 6.2% of the $2,500 = $155

For Medicare, you have to withhold 1.45% of the $2,500 = $36.25

The total FICA tax to withhold from Peter’s bi-weekly salary would be $155 + $36.25 = $191.25

Step 3: Calculate the state and local tax

State taxes are slightly different in each state. It’s up to you to check with the relevant authorities. However, there are other states where employees aren’t required to pay state income taxes.

Calculate the state and local tax - How to Calculate Payroll Taxes For Employees

These include:

  • Florida
  • Alaska
  • Nevada
  • South Dakota
  • Texas
  • Washington State
  • Wyoming

The amount of money you need to deduct from Peter’s salary for payroll taxes would be the sum of the federal income tax, FICA tax, and state tax (if applicable).

Federal income tax + FICA tax + state tax = Amount to withhold from the employee’s salary.

From Peter’s $2,500 paid bi-weekly, you’ll withhold $204 + $191.25 + 0 = $395.25.


Conclusion

You should now know how to calculate payroll taxes for employees. All it takes is to have a good understanding of the payroll taxes your employees are supposed to pay. These payroll taxes include the federal income tax, state taxes, and the FICA tax. The calculation side of things is fairly simple. Just be careful, you don’t want to withhold more than you should.

Remember, you must always pay your taxes on time to avoid penalties. The work might be tedious if your business has double or triple-digit employees. In such a case, you should consider getting outsourcing your payroll or setting up an automatic payroll system.