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.
Here’s how to calculate payroll in a nutshell.
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, which 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: Jim was hired 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 be compensated for it.
Because salaried employees’ work hours are fixed, they won’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 the pay rate stay the same.
There is an exception, however: 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 are protected by federal labor laws. The employees are expected 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 timesheet below, which you’ll want to have to make record keeping easier, the employee worked various hours from Monday through Saturday and none on Sunday. This employee’s total work time for the week (8.67 + 8.17 +8.75 + 8.75 + 7.08 + 2= 43.42) equals 43.42 hours. Please note you can always print timesheets using a free online timesheet 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.
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 5 minutes is the equivalent of .08 of an hour when calculating total work time.
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.
Let’s look at some sample payroll calculations.
How to Calculate Gross Pay for Hourly Employees
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
Federal laws regulate overtime (OT) pay and usually includes any hours worked over 40 in a seven-day workweek, and the rules in different states vary. For instance, in California, if employees work more than 8 hours in a day, the additional hours should be paid at a higher rate. If an employee works more than 8 hours but less than 12 hours, time and a half pay, which is 1.5 times the regular pay rate, is required. Double time, which is two times the regular pay rate, is required for any hours worked more than 12 in a day.
Let’s revisit Jenny from our example above and assume she worked 45 hours vs the 35 in a week. She lives in Arkansas though, so overtime is simply time and a half for all hours worked over 40 in a week, which would be five in this case (45 total hours – 40 regular = 5 OT hours)
First, we need to determine her OT rate. Her regular pay rate is $15 per hour.
$15 X 1.5 (time and half OT rate) = $22.50 per hour
Her overtime rate (the amount she should be paid for any hours worked over 40 in a week) is $22.50 per hour.
Let’s calculate her gross pay:
$15 X 40 regular hours = $600 regular pay
$22.50 X 5 OT hours = $112.50 OT pay
Add her regular and overtime earnings together:
$600 + $ 112.50 = $712.50
In this case, Jenny’s gross pay is $712.50.
Calculating Gross Pay for Exempt Salaried Employees
Let’s pretend Jenny is a salaried employee who has agreed to work a minimum of 40 hours a week. She’s exempt and worked 52 hours this week. Her annual salary is $50,000.
Here’s how to calculate Jenny’s pay for the week as an exempt salaried employee
40 hours/week X 52 weeks/year = 2,080 work hours per year
(Jenny will be paid for 2,080 hours in the year.)
$50,000 / 2,080 annual work hours = $24.04 per hour
(Jenny’s implied hourly pay rate is $24.04/hour).
Remember, Jenny is an exempt employee, so even though she worked overtime, which are usually any hours worked over 40 in a week, you don’t have to worry about paying for it.
You would calculate her gross pay using the pay rate and total work hours for the week as follows:
$24.04 x 40 hours = $961.60 gross pay
Every week, Jenny should be paid $961.60, no matter how many hours she works. She doesn’t need to submit time cards, because this amount is fixed. However, to ensure work-life balance is intact, it would be a good idea to monitor the amount of time she’s working each week. Working 50 or more hours per week while only being paid for 40 can lead to burnout quickly.
Calculating Gross Pay for Nonexempt Salaried Employees
Now, let’s imagine Jenny is a nonexempt salaried employee. This just means she is protected by federal labor laws and must be paid for overtime. However, she’s also a salaried employee and will be paid for a fixed minimum number of work hours each week.
To illustrate, we’ll use the same pay rate and work hour information we calculated above. Jenny is being paid $24.04 per hour ($50,000 a year) and worked 52 hours this week. Twelve of those hours (52-40 = 12) are considered OT and should be paid at the time and a half rate. In this case, the OT rate would be $36.06/hour ($24.04 X 1.5= $36.06).
$24.04 x 40 nonovertime hours= $961.60 regular pay
$36.06 X 12 overtime hours= $432.72 OT pay
$961.06 regular pay + $432.72 overtime pay = $1,393.78 gross pay
We had to add Jenny’s regular pay and overtime pay to find total gross pay. Look at the difference in pay between paying her as a nonexempt salaried employee and an exempt salaried employee ($1,393.78 versus $961.60). She worked the same number of hours but would receive considerably more as a nonexempt employee. Most employers choose the exempt route. However, if you think there will be a substantial amount of overtime in the position, you may want to consider making it a nonexempt position.
Other Components of Gross Pay
In addition to work hours, you’ll also need to account for employee bonuses, reimbursements, and other income when calculating total gross pay. Gross pay is a total of all income the employee received before any deductions are applied.
3. Add Payroll Deductions
Employees would love for you to compensate them their gross pay amount; you might benefit from this as well because you wouldn’t have to consider the other costs workers face when you set their pay rates. However, 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.
Nontax payroll deductions can include numerous items, such as:
- Insurance premiums: Health, dental, vision, and life insurance
- Retirement contributions: 401(k), 403(b), and individual retirement accounts (IRAs)
- 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 cell phone 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 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 to be 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 nontax 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. 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 taxes. 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. Several city and county taxes 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 .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 towards 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 like 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 nontax deductions and taxes calculated in steps three and four. At this point, you’ll deduct all withholding amounts from gross pay.
Take Jill’s gross pay, for example. It’s $2,600 for a two-week period. Total nontax 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 backend 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-paid or overpaid an employee, you can use an online retroactive pay calculator to compute the amount you need to pay the employee quickly, so the situation is resolved. Keep in mind, however, you’ll also need to determine the tax impact, so you can clear the air with the IRS. Using payroll software like Gusto makes it easy because all of the calculations—paycheck and taxes—are done for you.
Calculating payroll becomes more complex as you hire additional employees. Keep in mind, however, that 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 that you avoid penalties.
You can always start 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. 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.