Unemployment TAX & Claim Management

How to Calculate Payroll Taxes

Employers must calculate payroll taxes as part of business operations. Payroll taxes are a combination of federal, state and local taxes, and this could include income, Social Security and Medicare taxes. These taxes are withheld from employees’ paychecks and employers match amounts for Social Security and Medicare.

A company’s payroll tax responsibilities are not limited to deducting and paying taxes with each paycheck. Employers need to also perform the following actions:

  • Deposit tax dollars from employee paychecks
  • Prepare several different reconciliation reports
  • Notate payroll expenses in financial reporting
  • File reports with state and local agencies through American Payroll Association
  • Calculate and file payroll tax returns

Knowing how to calculate payroll taxes is critical to keeping your business in good standing. To make sure you are on the right track, follow the basic first steps below for calculating payroll taxes. Please keep in mind, depending on your accounting and payroll situation, some steps might vary.

Determine gross pay

The first step is to determine the employee’s gross pay. This includes hourly wages or salary, plus commission, overtime, tips and other taxable compensation. Deductions from retirement programs or savings plans and reimbursements from business expenses should not be calculated in the total gross pay.

Reference employee’s W-4

Look at the employee's W-4 form to find out filing status and withholding allowances. Then, multiply the number of withholding allowances by the number of one allowance for the filing status and the length of the pay period. Finish the calculation by subtracting this total and any tax deductions from the gross pay. This is the employee’s taxable income.

Figure out withholding amount for federal income tax

Calculate how much federal income tax should be withheld. This is determine by looking at a series of tax brackets with percentages that increase as income goes up. Look at this year’s tax tables to see what the exact figures are.

Calculate withholding amount for state or local income tax

The formula for each state varies, so it’s important to find the one that applies to you. Visit the Department of Revenue to find out how to calculate the state income tax in Arizona.

Compute employee contributions for Social Security and Medicare

Social Security and Medicare are flat rate taxes. To calculate Social Security for payroll taxes, multiply the employee’s gross pay by 6.2 percent. For Medicare, multiply gross pay by 1.45 percent. Don’t deduct Social Security if the employee’s income is above the annual income threshold.

Calculate federal (FUTA) and state (SUTA) unemployment taxes

These taxes are paid by the employer. SUTA taxes are calculated based on the state while FUTA taxes are 6.2 percent of the first $7,000 of an employee’s wages.

While these basic steps can get you started, knowing how to calculate payroll taxes comes with experience. With so many rules and regulations, it might be better to outsource payroll tax management to a payroll company. This could prevent costly errors and ensure your payroll taxes always get done correctly and on time.

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