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Payroll is one of the most important tasks for any organization, and it can be a financial burden on an employer. The right understanding of payroll could save employers significant amounts in tax liabilities by ensuring employees are properly paid according to IRS guidelines.
It’s critical to understand how to calculate payroll for your company before recruiting new staff. It will save you time and maybe thousands of dollars in penalties by avoiding paycheck disappointments, and it may even result in a decreased turnover. You may do the math yourself (hours worked X pay rate), utilize an internet calculator, or use the software.
Step 1: Calculate the total amount of time
To begin conducting payroll, you’ll need to determine how many hours each person has worked throughout the course of the period. These will be total work hours for hourly workers (and minutes if you want to pay exact amounts). It will be a defined amount of hours agreed upon at the time of employment for salaried employees (like a standard 40 hours, regardless of actual hours worked). At this time, you’ll also need to have decided on a payment schedule. This schedule indicates whether you pay staff weekly, bimonthly, monthly, or annually.
Salaried Employees’ Total Work Time
Your salaried staff should be paid the same amount each paid month (unless you have a nonexempt salaried position and are legally required to pay out overtime worked).
When you hire a new employee, you’ll agree on a fixed yearly wage and a specific amount of hours for which they’ll be compensated. When an exempt employee is employed on an annual salary basis, they must work at least 40 hours each week. They may work longer hours, but they should be aware that they will not be paid more. Most businesses do not need exempt workers to log their time since their work hours are usually predetermined.
Tip: Whether you’re considering payroll software, see if it has an autopilot option that calculates payroll automatically each month (without you having to do anything). Salaried workers’ paychecks are the simplest to automate since their hours worked and pay rate remains constant.
Salaried Employees
Nonexempt salaried workers, on the other hand, are exempt from this restriction. Although it is uncommon, some firms may give their nonexempt workers a salary, which entails a set weekly wage plus any overtime they perform.
Because of the nonexempt nature of the role, these workers are covered by federal labor laws. Employees are expected to work a certain amount of hours each week, but if they work more than that, they must be compensated at an overtime rate. To handle this effectively, time tracking is required.
Hourly Employees’ Total Work Time
Calculating total work hours for hourly employees is a bit more challenging than for salaried staff, but it’s not too difficult. Basically, you’ll sum up all of an employee’s hours and minutes for the pay period.
Assume that an hourly employee worked varying hours during the week from Monday through Saturday, but none on Sunday. Let’s add up those hours and minutes to obtain the overall number of hours worked throughout the course of the time.
Total work time for this week for this employee: 8.67 + 8.17 +8.75 + 8.75 + 7.08 + 2= 43.42 hours
Some firms are more stringent about when workers clock in and out (4 p.m. vs. 4:05 p.m.), making calculations simpler. However, if you need to convert minutes for payroll, there are lots of internet tools to assist you.
Step 2: Determine gross pay (Before Deductions & Taxes)
You can compute gross compensation after you know how many hours you’ll be paying each employee. Gross pay is an employee’s total compensation before taxes and other deductions, or, to put it another way, their pay rate multiplied by time worked.
For example, we’ll figure out Jenny’s weekly wages. She works 35 hours per week as an hourly employee who is paid $15 per hour. Her hourly wage is $525.
$15 multiplied by 35 hours is $525.
Step 3: Calculate Your Wage Deductions
Payroll deductions must be subtracted from an employee’s gross compensation before computing their final pay. We recommend producing a comprehensive record of each employee’s deductions, including whether they are pre-tax or post-tax. It’s important to remember that we’re segregating taxes from payroll deductions in this piece.
Non-taxable payroll deductions may include a variety of things, including:
- Premiums for health, dental, vision, and life insurance
- Contributions to 401(k), 403(b), and IRA accounts
- Kid support payments: A legal draft of your employee’s check is normally begun by the state where their child resides.
- Union dues
We just mentioned a handful, but there are many more that are specific to your workers or business. Some firms, for example, provide inexpensive mobile rates to workers who join their company’s phone plans. This may necessitate including employee phone expenses on your company’s phone bill; if you wanted to recuperate some of the money, you could charge them a little monthly fee and remove it from their paychecks (with their agreement, of course).
To obtain a total, you’ll need to put all of your payroll deductions together. Most deductions, such as insurance, have monthly premiums that are the same amount, however, others are depending on the employee’s compensation for the time (retirement contributions).
Simply calculate the percentage the employee wants to be withheld (say, 4%) by the gross pay amount (say, $850) to get the total you should withhold in pay-based circumstances.
$850 divided by 4% (0.04) is $34.
Step 4: Calculate the Total Payroll Taxes
You’ll need to figure out how much money your workers owe in taxes. Without a payroll calculator, this may be difficult. When your workers are hired, they should fill out a W-4 form, which you can use to figure out what proportion of their pay you need to withhold for federal, state, and local taxes. The Internal Revenue Service (IRS) is also a valuable resource.
The following is a list of payroll taxes that you may be required to monitor, withhold, and deliver to the relevant agencies:
- Most workers are liable to federal income taxes unless they are minors or earn too little to be exempt.
- State income taxes: While some states, such as Florida and Texas, do not levy a state income tax, many others do. Some have a set rate, while others charge a percentage dependent on the employee’s salary (if they earn more, you withhold a higher percentage).
- Local income taxes are less prevalent than state income taxes. States like New York and California have a variety of them, so be sure to save money for all of them.
- Social Security: This is a 6.2 percent levy that goes to the government’s retirement fund for each employee. It no longer applies after an employee makes $132,900 per year. You must additionally pay a 6.2 percent penalty (in addition to what the employee pays).
- Medicare is a 1.45% levy that goes to the government’s medical fund for the elderly. This one has no income limit, but you must contribute a matching amount from your company finances.
Income Tax Rates
One of the most perplexing aspects of payroll processing is determining how much you should withhold in taxes. The amount of income tax you pay depends on the information on your employee’s W-4 form, such as their marital status and the number of allowances they claim. To figure out how much to withhold for federal income taxes, use the IRS withholding calculator.
Calculating tax numbers manually may become a difficult process as your company expands. If you’re not ready for an all-in-one payroll software like Gusto, free payroll software can be a good alternative.
When it comes to state income tax rates, you should expect to withhold around 10% or less; however, if you work in a state like California or Hawaii, which have historically had the highest state income tax rates, your employees may be responsible for paying anywhere from 11% to 13% of their earnings. If you operate in New York Municipal or your workers reside in Yonkers, for example, you may be subject to a variety of city and county taxes.
Subtract nontaxable income.
Nontaxable income must be taken into account when calculating employee taxes to withhold since it must be excluded from your calculations. This might include work-related expenses that the employee purchased with their own money and which you must now refund. To avoid withholding too much, be sure to subtract these amounts before computing any taxes.
For example, Fern’s weekly gross income is $3,500. $350 of that is for a refund she is getting for a hotel stay she spent on the company’s behalf. Her state income tax rate is 9%. She owes the state $283.50 in taxes.
$3,500 gross compensation minus $350 in accommodation expenses equals $3,150 in taxable income. $3,150 in taxable income multiplied by 0.09 equals $283.50.
Payroll Taxes and Other Payroll Expenses for Employers
It’s not the most thrilling aspect of being an employer, but it’s important if you don’t want to spend extra money on fines and costs.
The following is a list of taxes and other payroll-related expenditures that you must pay from your company’s bank account:
- Employees pay FICA taxes, which include Social Security and Medicare. You’ll pay Social Security at 6.2 percent of their salary and Medicare at 1.45 percent.
- Workers’ compensation: Most states require companies to acquire workers’ compensation insurance in order to safeguard their employees in the case of a workplace accident. Rates vary based on past claims, length of time in the company, industry, and other criteria.
- Unemployment taxes (or insurance): Both state and federal unemployment insurance may be due. This money goes to government funds, which are used to give money to workers who are not working.
- Premiums for the Family Leave Act: Some states (such as California and New York) require you to pay a fee for family leave insurance. This money goes into the accounts that pay workers when they go on vacation or for major events (childbirth). Employee premiums might be as little as $1 per month.
- Some states compel you to contribute to their disability fund as well. The rules and rates vary per state, but they are typically based on criteria such as your overall payroll.
Step 5: Subtract Taxes and Deductions from Gross Pay
Start with the gross amount you computed in step two to arrive at the employee’s final paycheck amount. In addition, you’ll need the total non-tax deductions and taxes from stages three and four. Simply subtract all withholding amounts from gross pay at this time.
Let’s use Jill’s gross compensation as an example. It costs $2,600 for two weeks. Total tax deductions are $440, and total non-tax deductions are $343. You would execute a check or direct deposit in the amount of $1,817, which is her net salary.
Net Pay $2,600 – ($343 + $440) = $1,817 Gross Pay – (Non-Tax Deductions + Tax Deductions) = Net Pay
You should be able to prevent employee lawsuits, IRS fines from erroneous and/or late tax payments, and all of the back-end effort that goes into rectifying payroll issues if you follow these methods for computing payroll.
Despite having all of the necessary tools, everyone makes errors from time to time. If you discover that you have underpaid an employee, you may use a retroactive pay calculator to rapidly calculate the amount you must pay the employee in order to fix the problem.
Conclusion
Payroll calculations get increasingly complicated when you recruit more staff. However, keep in mind that the procedures are practically the same. The ultimate objective is to pay all workers and tax authorities on time and in the proper amount. While some businesses prefer to do everything by hand, others utilize internet resources such as payroll calculators and software. To prevent fines, acquaint yourself with IRS tax guidelines and federal payroll standards, regardless of the software you use to compute payroll.
