Calculating Payroll Taxes

By Stefan Schumacher, editor of The Payroll Blog

If you’re new to payroll, figuring out how to calculate payroll taxes can be a daunting task. As you take over as the bookkeeper or payroll administrator for your business, you’ll want to gather a basic understanding of the process.

When we talk about payroll taxes, we’re referring to federal, state and local taxes withheld from employee’s paychecks by the employer. Sounds fairly simple, however this includes not only income taxes, but Social Security and Medicare (sometimes called the “payroll tax”). The “payroll tax” rate for Social Security is 6.2 percent. Also note the 6.2 percent Social Security rate is owed by both employee and employer, making the total Social Security rate the employer must pay 12.4 percent.

And there are two payroll taxes – FUTA (Federal Unemployment Tax Act) and SUI (state unemployment insurance) – paid by the employer. Unless you live in New Jersey, Pennsylvania or Alaska, where both the employee and employer contribute.

One form you’ll want to become familiar with is the employee’s W-4. It is based on this form that federal and state income taxes are calculated. The IRS provides the income tax calculation based on selections and entries made on the W-4 form. Each state’s tax board has a calculation for the tax withheld. (Note: an employee can choose to withhold more than is required by the IRS).

Keeping up with the tax rates is an important part of calculating payroll taxes. Currently, as discussed above, the Social Security tax rate is 6.2 percent; Medicare is 1.45 percent (an additional Medicare rate of 0.09 percent is owed on wages in excess of $200,000), meaning the employer owes those percentages to the IRS. Another change is the Social Security Wage Base, which has gone from $113,700 in 2013 to $117,000 in 2014, meaning you can’t be taxed on any more than that amount. There is not a similar limit on taxation of Medicare.

The rate for FUTA is 6.0 percent, however tax credits can significantly reduce this rate. FUTA’s wage baseline is $7,000. The SUI rate depends on unemployment claims from employees who have been let go.

As you can see, a lot goes into calculating payroll taxes, which is why many businesses choose to use a payroll service or outsource payroll to an accountant.

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