Employee payroll taxes are federal and state taxes that the employee pays. These are deducted from your employee's wages each pay.
But when we're talking about how to do payroll, and trying to calculate payroll, there are many pieces to this puzzle, not just taxes. Gross wages, employee payroll taxes, employee benefit withholdings, and net pay are the main pieces or parts of an employee's pay, and we want to discuss them here.
Payroll by section
In order to fully explain the "how to calculate" part of how to do payroll, I will explain the different sections or parts of your small business payroll.
**Gross Wages (hours worked x hourly wage)
**Federal Taxes (federal withholding, social security, medicare)
**State and Local Taxes (vary by locality – state, city, school tax, etc.)
**Benefits withholding (employee’s share of medical/dental benefits)
**401(k) contributions (employee contributions to a pension plan)
**Child Support withholding (payments to your local child support agency)
**Net Pay (what’s left!)
Whew! That may seem like a lot, but once you get the hang of it, it’s not that hard, really!
Now let’s go thru each of those parts.
Think of gross wages as meaning ‘without any deductions’.
Gross wages can be broken down into many subcategories, like hourly, overtime, vacation, sick, salary, commission, etc.
Hourly vs Salary vs Commissions
If an employee is Hourly, the get paid a set hourly wage, for example, $10 per hour, and they get paid for the number of hours they work. You must abide by the federal and state minimum wage laws, so make sure to go online to the Department of Labor website for up to date minimums.
If an employee is Salary, they get paid a set amount each pay period. A salary is usually stated in an annual form, such as $30,000 per year.
To figure out a weekly pay on an annual salary, take the salary divided by 52 weeks/year. For $30,000, that calculation would be $30,000 / 52 = $2500.
To figure out a bi-weekly pay (every other week) take $30,000 / 26 (52 weeks divided by 2).
To figure out a semi-monthly pay (15th and 30th) take $30,000 / 24 pays/year (twice each month).
If an employee gets paid on Commission, that means they earn a percentage of the sales they bring in. Insurance, Auto and Real Estate industries pay this way, among others. Commissions are usually paid monthly, after you’ve had a chance to calculate your sales, and then calculate the employee’s percentage.
Independent Contractor vs Employee
A word of caution here. Many times small business employers want to pay an employee as an independent contractor, thinking they can sidestep the whole employee payroll taxes issue all together.
The IRS has 3 categories of information they use in determining if a worker is an employee or an independent contractor.
1. Behavioral – who controls what the worker does and how the worker does it? If you control when they work and what they do and how they do it, they’re an employee.
2. Financial – how is the worker paid? Are expenses reimbursed? Who provides the tools or supplies needed to do the job? If you pay them by hour on a regular basis, reimburse them for expenses incurred, and supply all the tools and supplies, they are an employee.
3. Type of Relationship - Is there a contract? Are there benefits (pension, insurance)? Will the relationship continue? Is the work performed an integral part of the business? If you’re answering yes, you have an employee.
If you treat an employee like an independent contractor, you could, if caught by the IRS, be liable for back employment taxes. Don’t chance it. Do your small business payroll by the books, and you will sleep well at night.
There are 3:
Federal Withholding Tax
This employee payroll tax is based on the gross wage and the number of dependents (exemptions) that an employee claims on their Form W-4. There are tax tables online at www.IRS.gov, but they are also in the IRS Circular E (booklet). You will get this booklet full of information on how to do payroll from the IRS when you get your EIN.
If an employee makes a large wage, you may have to calculate the withholding, as the tables only go up to a certain level, then the percentages take over.
Social Security Tax
This employee payroll tax has two parts, the employee portion, and the employer portion. You each pay 6.2% of the gross wage. The employee pays their share out of each paycheck. You the employer then add your percentage to the employee’s percentage, then pay that to the IRS on a regular basis.
This tax also has two parts, employee and employer, the same as above, only the percentage is 1.45% of gross wages.
ASIDE: 941 Tax Deposits
Quite simply, each pay period when you do payroll you add all the federal withholding taxes for all your employees, add to it all the employee’s share of Social Security tax and Medicare tax, and then add to that all the employer’s share of Social Security and Medicare tax. This amount is deposited to the IRS. It is called a 941 Deposit.
This is either monthly (you pay the IRS each month) or semi-monthly (you pay the IRS on a set date after your pay date. This is all explained in the Circular E you will receive from the IRS. For example, though, if you do payroll on Friday, you must make your 941 tax deposit by the following Wednesday. You can pay this tax at a bank, online, or over the phone. This is called EFTPS, the Electronic Federal Tax Payment System. You have to sign up for this, so go online to www.IRS.gov, then search for EFTPS.
Each state will have the following employee payroll taxes or variations of such:
State Withholding Tax
This employee payroll tax is the state version of the federal withholding tax. Again, the employee designates how many dependent exemptions they will claim, and you use a tax table to figure the correct withholding, based on the gross wage and number of exemptions.
You will pay this to your state either monthly or quarterly, based on the size of your payroll.
Local Withholding Tax
This employee payroll tax is a local tax that the employee pays based on their gross wages. This could be an employment tax (because they work there) or a residential tax (because they live there). An employee could be hit twice if they live in a city with a residential tax, and work in a different city with an employment tax.
This is paid monthly or quarterly, again depending on the size of your payroll.
School District Tax
This employee payroll tax is a local tax for the benefit of the local school district, and is voted into passage by the residents. This will be a percentage of the employee’s gross wages. You should be able to find this thru your State website. I know Ohio School District Taxes can be located thru the Ohio Dept of Taxation website. This is paid, yep, monthly or quarterly, based on the size of your payroll.
Benefit withholding is similar to an employee payroll tax in that you are required to withhold a certain amount from the employee's pay, and remit that amount to an outside party.
The benefits that most employers provide are medical insurance, dental or eyeglass insurance, life insurance, and some sort of disability insurance.
To start such a program, you need to call around to different insurance agents, and get some quotes.
You do have some options regarding payment.
Provide employer-paid coverage (you pay it all) Provide partially paid coverage, and ask the employee to pay a set amount per month Provide the medical coverage for the employee, but have them pay dependent coverage Provide medical coverage, but ask the employee to pay any other coverage they want.
401(k) plans are retirement plans that the employee contributes part of their wages to each payroll. The employee specifies what percent of their wages they want to contribute, usually anywhere from 1% to 10%.
You as the employer then subtract (withhold) from the employee's gross wages that percentage, say 5%, then you cut a check for that amount and send it to the company you wrote your plan with (your plan administrator).
This is the essence of "withholding". You withhold from the employee's gross pay, then you send that money somewhere else, be it the IRS, the state or locality, or your benefits administrator.
Child Support wihholding is a highly regulated area now. This is not an employee payroll tax but it is a regulated withholding. Usually the county Child Support Enforcement Agency (CSEA) will send you a notice in the mail. They will tell you how much to withhold for your employee based on the amount due and how often you pay your employees.
This money should be sent in to the CSEA the day you do payroll. You are allowed to withhold a small fee, I think it's either $2 or $5 per pay (the notice will tell you) to cover your costs in this process. I never did, but it's up to you.
Net pay is what's left after you deduct all these deductions from the employee's gross wages.
This is the amount that goes on the employee's pay check.
So you take Gross Wages, minus all the employee payroll taxes - Federal Withholding Tax, Social Security and Medicare Taxes, and State and Local Withholding Taxes - and minus any Benefits withholding, 401(k) Contributions, or Child Support withholding.
That's Net Pay.
But, you ask, how do you calculate those employee payroll taxes?
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