How to calculate payroll taxes for small businesses

How to withhold, employer contributions and compliance, step by step

But there’s more to payroll than just writing checks. Employers are responsible for accurately computing payroll taxes, withholding the proper amounts from employees, remitting employer contributions and meeting report and deposit deadlines. This matters — getting this right protects your business from penalties and ensures that employees are paid correctly. This guide explains the parts of payroll taxes and outlines an easy calculation process that any small business owner or bookkeeper can follow.

Understand the core components

• Payroll taxes consist of a number of distinct obligations. For most small employers, there are two kinds of these: the employee-withheld taxes and employer-paid taxes.
• Employee-withheld taxes: Withheld from each employee’s gross wages. Common ones include the withholding of federal income tax, state and local income withholdings if applicable and payroll taxes related to social programs split between employee and employer.
• Taxes paid by the employer: Rather than being deducted or withheld from employee wages, employers must pay taxes for their employees such as an employer share of contributions to social programs like Medicare and Social Security, unemployment taxes and various state-specific assessments.
• Before crunching numbers, verify these variables: pay period (weekly, biweekly, semimonthly or monthly), individual employee gross pay for the period, individual employee tax withholding status and allowances and any pretax deductions (retirement contributions, benefits) that decrease taxable wages.

Step-by-step payroll tax calculation

Calculate gross pay

For hourly workers: hours worked × hourly rate (+, overtime rules)

Salaried workers: divide annual salary by number of pay periods

Subtract pre-tax deductions

Subtract the pre-tax things for which there are qualifying exclusions, such as contributions to certain retirement plans and health premiums, resulting in taxable wages for income tax purposes.

Compute employee tax withholdings

Income tax withholding: Determine the income tax to withhold for a pay period using the employee’s withholding information and appropriate federal and state withholding tables or formulas.

Payroll contributions (employee share): Calculate taxes owed by employees to the various social programs, considering taxable wages and percentage as of current rates.

Calculate employer payroll taxes

Employer-Social program contribution: Employee Taxable Wages x employer rate

Employer unemployment taxes: Calculate federal and state unemployment tax based on the taxable wage base and rates that apply in each location. Some states apply experience-based rates.

Add other payroll items

Deduct post-tax items such as wage garnishments, or voluntary deductions after tax(running total of all taxes are calculated).

Calculate net pay and employer total cost

Net pay = gross pay – the sum of all employee withholdings and post-tax deductions.

B. Employer total cost = gross pay + employer payroll taxes + employer-paid benefits

Practical example

For example, if an hourly employee is paid $20/hour and work 80 hours in a biweekly pay period:

Gross pay = 80 × $20 = $1,600

Pre-tax retirement contribution = $80 (5% of gross)

Income subject to payroll taxes = $1,600 − $80 = $1,520

Assuming that Social Program Tax Rate for Employee is 7.65% (employee share), and Employer share as Employee Share:

Employee social tax = $1,520 ×0.0765= $116.28

Employer social tax = $1,520 × 0.0765 = $116.28

Suppose for the period income taxes withheld is $150 and unemployment tax for taxable wages is $20 employer side:

Employee withholdings = $150 + $116.28 = $266.28

Net pay = $1,600 − $80 − $266.28 = $1,253.72

Total cost to employer = $1,600 + $116.28 + 20 = $1,736.28

This simple example illustrates how pre-tax deductions lower withholding bases and employer taxes contribute to the overall cost of labor.

Key employer responsibilities and schedules

• Withholding Preciseness: Collect finished withholding structures from representatives and revise when their status changes. Apply the correct withholding tables.
• Deposit schedules: Based on your total liability, the employer deposits of withheld taxes and employer contributions are geographically based either monthly or semi-weekly. "Missing deposits could result in penalties and interest.
• Filing and reimbursing: Periodical returns for wages paid and taxes taken. Totals are confirmed through annual reconciliations, and wage statements provided to employees. Acknowledge state-specific filing requirements too.

Worker classification matters

Getting worker classification correct as employees vs. independent contractors shifts payroll tax responsibilities. Employees are entitled to tax withholding and employer tax contributions; independent contractors receive gross payments and must take care of their own taxes. Poor classification could lead to back taxes and penalties, so give thought to worker status before you pay.

Mistakes and how to prevent them

• Wrong withholdings: You should regularly collect withholding forms of employees and change the amount in a payroll when necessary (wedding, second job, etc).
• Ignoring local taxes: City or municipal taxes can apply. Verify any withholding and remittance local requirements.
• Missing deposits: Avoid calendar faux pas and ensure deposit milestones are confirmed in writing.
• Ignoring taxable wage limits— Some employer taxes only apply to wages up to a limit, so watch year-to-date wages.

Payroll Tax Compliance: How to Simplify It

• You must keep those records of payroll, showing gross wages, deductions and deposits for each pay period.
• Compare payroll tax liabilities to deposits regularly so the errors can be spotted early on.
• Budget for employer tax obligations as part of labor cost planning — typically 7%–15%, or more depending on unemployment rates and benefits.
• Get a payroll calendar up and running with pay dates, deposit windows, filing deadlines.

When to seek professional help

If you employ people in multiple states or run multi-layered benefit plans, or if you are dealing with any uncertainty regarding how to categorize your workers, having specialist help can minimize compliance risks. Outsourcing some payroll tasks or working with a professional tax expert can help reduce the time spent on developing your payroll approach, and also minimize costly errors.

Conclusion and quick checklist

• Review classifications of employees and withholding forms.
• We calculate gross pay, pre-tax deductions for each period paid, and employee withholding and employer taxes.
• Monitor deposits schedules and ensure periodic returns are filed.
• Maintain accurate records and do regular reconciliations.
• Maintaining a consistent process to calculate payroll tax keeps your business safe and also helps your employees. Use this guide as a basic workflow and modify details to fit your jurisdiction and business size.