Before hiring employees, spend time learning how to calculate payroll for your business. It’ll save you time from having to correct errors and thousands of dollars in penalties; you might even experience lower turnover by eliminating paycheck frustrations. You can perform calculations manually (hours worked X pay rate), using an online calculator, or with software.
You can always start out calculating payroll by hand and switch to an affordable payroll software like Gusto later. Once you finish Gusto’s set up process, you can set some paychecks on autopilot (those that don’t change from week to week). And it’s still pretty easy to enter work hours for employees who work different schedules each week. If you’re interested in seeing how it works, Gusto offers a free 30-day trial.
1. Determine Total Time Worked for the Period
To start doing payroll, figure out how much time each employee has worked for the period. For hourly employees, this will be total work hours (and minutes if you want to pay exact amounts). For salaried, it’ll be a set number of hours agreed upon at the time of hire (like a standard 40 hours, regardless of actual hours worked). You’ll also need to have selected a pay schedule at this point. This schedule means you should know if you’re paying employees weekly, biweekly, or on some other cadence.
Total Work Time for Salaried Employees
You should pay your salaried employees the same amount per pay period (unless you have a nonexempt salaried position and are legally required to pay out overtime worked). Upon hiring an employee, you’ll determine a set annual salary amount and a guaranteed number of hours for which they will be paid. Knowing this information will help you calculate how much you should be paying each salaried employee each pay period.
Consider this example: B&B Tax Solutions hires Jim to be a staff accountant at a $50,000 annual salary rate. Since his position is exempt and salaried, B&B’s Tax Solutions expects him to work a minimum of 40 hours each week; he can work more but won’t get compensation for it.Salaried employees’ work fixed hours, so they don’t need to document their working hours for payroll purposes. If you’re using or plan to use payroll software, check that it has an autopilot feature that automatically calculates payroll each period (without you having to do anything). Paychecks for salaried employees are the easiest to automate because their hours worked and pay rate stay the same.
Nonexempt Salaried Employees
There is an exception, though: nonexempt salaried employees. Although not as common, some employers will pay their nonexempt employees a salary, meaning a guaranteed amount each week, along with any overtime they work. The nonexempt part of the position means these employees fall under federal labor law protection. The employer expects the employees to work the set minimum number of hours each week, but if they exceed those hours, employers must pay them overtime. This requires time tracking to manage successfully.
Total Work Time for Hourly Employees
Calculating total work time for hourly employees is a little more involved than it is for salaried workers but not too complicated. Essentially, you’ll add all of the hours and minutes an employee worked for the pay period.
For instance, in the time sheet below (which you’ll want to keep to make record keeping easier), the employee worked various hours from Monday through Saturday and none Sunday.
This employee’s total work time for the week:
8.67 + 8.17 +8.75 + 8.75 + 7.08 + 2= 43.42 hours
Please note you can always print time sheets using a free online time sheet template. You can also enter their work hours into an online Google Sheets timecard calculator as long as employees are allowed to verify the hours are correct at the end of each pay period.
Be sure to have employees sign their time sheets, so you are protected if they dispute their pay later
Some employers are stricter about the time their employees clock in and out (4 p.m. vs 4:05 p.m.), so calculations are easier. Nevertheless, if you find yourself needing to convert minutes for payroll, there are plenty of online resources to help. A conversion chart like the one below makes it easy to see that five minutes is the equivalent of 0.08 of an hour when calculating total work time.
Use this conversion chart to ensure your employees are paid for every minute they work
2. Calculate Gross Pay (Before Deductions & Taxes)
Once you know how many hours you’ll be paying per employee, you can calculate gross pay. Gross pay is the total pay an employee earns before taxes and other deductions are subtracted, or more simply put, their pay rate multiplied by time worked.
As an example, we will calculate Jenny’s earnings for the week. She’s an hourly employee who is paid $15 per hour, and she worked 35 hours this week. Her gross pay is $525.
$15 X 35 hours = $525
Using a free online hourly payroll calculator makes it easy to find an employee’s gross pay
3. Add Payroll Deductions
Legally, you must subtract payroll deductions from gross pay before determining their final payout amounts. We suggest compiling a full list of the deductions each employee has. One thing to keep in mind is that in this article, we are separating taxes from payroll deductions.
Non-tax payroll deductions can include numerous items, such as:
- Insurance premiums: Health, dental, vision, life insurance
- Retirement contributions: 401(k), 403b, IRA accounts
- Child support payments: This is a legal draft of your employees’ check that’s usually initiated by the state in which their child lives
- Wage garnishments: The court can garnish an employee’s paycheck when they don’t pay their debts; third-party debtors can sue them, and they will be liable
- Union dues: Membership fees for being a part of the union
We just listed a few, but there are plenty more that may be unique to your employees and/or your company. For instance, some companies provide benefits like low cellphone rates for employees joining their company phone plans. This might require you to include employee phone charges on your business’ phone bill; if you wanted to recoup some of the money, you could charge them a low monthly cost (with their approval, of course) and deduct it from their paychecks.
You’ll need to add all payroll deductions together to get a grand total. If you need help, a free online payroll deductions calculator can help. With insurance, the premium is usually flat, meaning the total is the same each month. Most of the other deductions are typically flat as well, but you may encounter some that are based on the employee’s pay for the period (retirement contributions). In those cases, just multiply the percentage the employee wants withheld by the gross pay amount to find the total you should withhold (4% of $850 = $34).
4. Find the Sum of Payroll Taxes
Similar to how you add the non-tax payroll deductions, you’ll need to find the total taxes your employees owe. This can be tricky without using a payroll calculator. Your employees should have completed a W-4 form upon hire; you can use this to help you figure out the percentage of their income that you need to withhold for federal, state, and local taxes. The IRS is also a good resource.
Here’s a list of payroll taxes you may have to manage (and by manage, we mean track, withhold, and send to the appropriate agencies):
- Federal income taxes: Most employees are subject to this, unless they’re minors or are exempt because they earn too little money.
- State income taxes: States like Florida and Georgia don’t have a state tax, but many others do. Some are a flat percentage, and others charge tax based on the employees’ income level (if they earn more, you pay a higher percentage).
- Local income taxes: Local taxes aren’t as common as state. States like New York and California have several different ones, so be sure to withhold money for all that apply.
- Social Security: This is a 6.2% tax that goes toward each employees’ government retirement fund. Once an employee earns $132,900 in a year, it no longer applies. You are also responsible for paying 6.2% (in addition to what the employee pays).
- Medicare: This is a 1.45% tax that goes toward the government medical fund for seniors. There is no income cap on this one, but you must also pay a matching amount out of your business funds.
Federal, State, & Local Income Tax Rates
Deciding how much you should withhold in taxes is probably one of the most confusing parts about being an employer. Income tax rates can vary depending on your worker’s W-4 information like marital status and the number of allowances they claim. Use the IRS withholding calculator to determine how much to withhold for federal income taxes. Of course, this can become cumbersome as your business grows, at which point even free payroll software would be a better option.
When it comes to state income tax rates, you should expect to withhold around 10% or lower; however, if you are in a state like California or Hawaii, that traditionally has the highest state income tax rates, your employees could be responsible for paying from 11% to 13% of their income. There are a number of city and county taxes that may apply as well; for instance, if you operate in New York City or your employees live in Yonkers.
Subtract Nontaxable Income Before Calculating Tax Amounts
Nontaxable income is important to consider when figuring employee taxes to withhold, because you will need to exclude it from your calculations. This can include work-related amounts that the employee paid using their own money that you now need to reimburse. Be sure to deduct these amounts before calculating any taxes.
Example: Fern’s gross pay for the week is $3,500. And $350 of that is for a reimbursement she is receiving for a hotel stay that she paid on behalf of the company. Her state tax rate is 9%. She owes $283.50 in state taxes.
$3,500 gross pay – $350 in hotel reimbursement= $3,150 taxable income
$3,150 taxable income X 0.09 = $283.50
If we applied the tax to her gross pay before deducting the $350 reimbursement, we would withhold $315, which is $31.50 too much ($315 – $283.50).
Employer Payroll Taxes & Other Payroll Expenses
In addition to the taxes you need to withhold (and remit) for employees, you are also responsible for payroll taxes. It’s not the most exciting part about being an employer but is necessary to avoid paying additional money in penalties and fees.
Here’s a list of taxes and other payroll-related expenses you are responsible for paying out of your business’ bank account:
- FICA taxes: These are the Social Security and Medicare taxes that employees pay. You’ll pay 6.2% of their income for Social Security and 1.45% for Medicare. The same income limitations apply.
- Workers’ comp: Most states require employers to purchase workers’ comp insurance to protect employees in the event of an injury in the workplace. Rates vary, depending on factors like previous claims, length of time in business, industry, and so on.
- Unemployment taxes (or insurance): You may be liable for both state and federal unemployment insurance. This goes toward government funds from which money is distributed when employees aren’t working. The federal rate is 6%, but state rates vary.
- Family Leave Act premiums: Some states (like California and New York), require you pay money toward family leave insurance. This funds the accounts that pay employees when they take leave for big events (childbirth). Premiums can be less than $1 a month per employee.
- Disability insurance: Some states also require you pay into their disability fund. Rules and rates vary by state, but usually depend on factors like your total payroll amount.
When it comes to state taxes, everything can vary. Be sure to check your state website regularly to stay in the know about required payroll taxes and expenses. Once you have a working list of taxes and expenses that both you and your employees owe and a strategy for calculating them each pay period, finding the total will be easy. Just make sure you keep your employees’ taxes separate from yours (employer).
5. Subtract Deductions & Taxes From Gross Pay
To reach the employee’s final paycheck amount, you should start with the gross amount you calculated in step two. You’ll also need the total non-tax deductions and taxes calculated in steps three and four. At this point, you’ll simply deduct all withholding amounts from gross pay.
Take Jill’s gross pay, for example. It’s $2,600 for a two-week period. Total non-tax deductions equal $343, and total tax deductions equal $440. Her net pay amount would be $1,817, so you would process a check or direct deposit in this amount.
$2,600 – $343 – $440 = $1,817
If you follow these steps to calculating payroll, you should be able to avoid lawsuits from employees, IRS penalties from inaccurate and/or untimely tax payments, and all of the back-end work that goes into correcting payroll errors—updating paperwork, processing correcting journal entries, and the negative workplace politics.
After you determine net pay, be sure to check it for reasonableness. Your total payroll expenses each period should follow a certain trend. If any amounts, total or individual, appear to be too high or low, do a little research before distributing to employees.
Of course, everyone makes mistakes from time to time. If you do happen to find that you short- or overpaid an employee, you can use an online retroactive pay calculator to quickly compute the amount you need to pay the employee so the situation is resolved. Keep in mind though, you’ll also need to determine the tax impact, so you can clear the air with the IRS. Using a payroll software, like Gusto makes it easy, because all of the calculations (paycheck and taxes) are done for you.
Bottom Line
Calculating payroll becomes more complex as you hire additional employees. Keep in mind though, the steps are essentially the same. The ultimate goal is to pay employees and all applicable tax agencies the correct amount and on time. Some employers start out using pen and paper to help but eventually transition to using online tools like payroll calculators and software. Whatever you use to help you calculate payroll, be sure to familiarize yourself with IRS tax rules and federal payroll laws so you avoid penalties.
You can always start out calculating payroll by hand and switch to an affordable payroll software like Gusto later. Once you finish Gusto’s set up process, you can set some paychecks on autopilot (those that don’t change from week to week). And it’s still pretty easy to enter work hours for employees who work different schedules each week. If you’re interested in seeing how it works, Gusto offers a free 30-day trial.
