How Do I Calculate My Employees’ Paychecks?

Most employees don’t want to think about the deductions that lower their take-home pay. However, as an employer, you should thoroughly understand everything that goes into (and out of) your employees’ paychecks, so you can help them figure out what their salary after tax will be. There are big financial implications for getting it all right, and employees will occasionally show up with questions like these:

  • “What is my gross income?”
  • “What percentage of my paycheck is withheld for federal taxes?”
  • “How much will my check really be?”

Fortunately, you’re not on your own. Follow these eight steps to figure out how to calculate an employee’s take-home pay, while answering all of the paycheck questions that come your way:

1. Tally your employee’s gross wages from their employment agreement or timesheet

Most paychecks start with gross wages, which is the amount of money an employee has earned during a specific pay period. This reflects the pay frequency, which is typically in weekly, biweekly, semi-monthly, or monthly increments. Gross wages include tips, commissions, and overtime (if it applies to them). It’s all of the money employees receive before deductions and taxes are taken out.

For hourly employees, it’s the number of hours they worked times their pay rate—which should be adjusted if there’s overtime. If someone’s on salary, their gross earnings will be their annual salary divided by the number of pay periods each year.

2. Subtract elective pre-tax withholdings

If employees choose, some amounts may be withheld from their paychecks on a pre-tax basis, which lowers their taxable income—and your payroll taxes. These are called non-taxable employee wages, meaning they have no taxes withheld. (This is the opposite of taxable wages, which do have income taxes withheld.)

That means you should take these pre-tax deductions out of your employee’s gross pay before the calculations for income tax and other taxes are deducted.

Elective pre-tax withholdings include benefits like:

3. Subtract employee-only taxes

Certain employment taxes only affect your employees (not you, the employer). You’ll withhold and set aside these funds and remit them to the government on behalf of your team as part of your payroll process.

It’s important to make those deposits on time, in the right amount, and in the right way. If not, your small business will face a lot of penalties from the Internal Revenue Service (IRS). For when and how to make deposits, refer to IRS Publication 15 (Circular E). The biggest tax deduction is for federal, state, and local income tax withholding.

Federal income tax

Your employees will most likely want to know how to calculate their federal withholding. You can determine how much federal income tax to deduct by looking at three factors:

  • The employee’s taxable gross wages (after pre-tax withholdings are removed)
  • Their marital status (indicated on their W-4 form)
  • The number of allowances they have claimed (also on their W-4 form)

These factors affect your employee’s tax rate, so be careful to calculate this correctly.

Once you know those three details, determine their federal withholding amount by using the IRS Publication 15-T. Choose either the percentage method or the wage bracket method, and use the appropriate chart to help you through it.

State taxes

Most states have an income tax as well. But rates vary widely across state lines—from zero percent in states like Florida to up to 14.4% as the top rate in California (13.3% marginal rate plus a 1.1% payroll tax on wage income). These are the state individual income tax rates and brackets for 2024.

In addition to income taxes, State Disability Insurance (SDI) is also subtracted in states where an employee is expected to make a contribution (i.e., California, New Jersey, and Rhode Island). In Hawaii and New York, employers cover the full cost of the SDI or employers or they can take an allowed amount from employees’ paychecks to pay for part of it.

Be sure to check the regulations where you live to see what is due. If your employees live in many different states, you’ll need to figure out each individually according to the state where they perform their work.

City and local taxes

Some cities also take a piece out of employees’ paychecks.

These local income taxes come in all sorts of flavors, too. Some are flat, like the 1% rate in Birmingham, Alabama, while others are complex, like the bracketed system in Washington, DC. These rules vary depending on the city where your business is based and where your employee lives.

Check with a local payroll expert to make sure you’re not missing anything.

4. Subtract other taxes (that both employees and employers must pay)

There are a few paycheck deductions that must be paid by both employees and employers. These are collectively known as FICA taxes. However, only the employee’s share will show up on their pay stub.

Social Security tax

The Social Security Act of 1935 was enacted to give citizens a supplemental form of income for their retirement. Both the employer and employee each contribute 6.2% of that employee’s gross income (up to a taxable maximum of $168,600 in earnings for 2024) for a total of 12.4%.

If wages are more than $168,600, no extra Social Security tax is withheld.

Medicare tax

Every employee must pay 1.45% of their paycheck toward Medicare. Employers also contribute an additional 1.45%. Unlike Social Security, there is no upper limit, so all gross income is taxed.

After your employee reaches a cumulative gross pay of $200,000, they’ll be subject to additional Medicare withholding at a 0.9% rate.

5. Subtract voluntary and involuntary deductions

In addition to taxes you withhold, there are other categories of paycheck deductions that can show up on a pay stub and lower your employee’s net pay.

Here are a few more items you may need to take out of your employee’s final paychecks:

Wage garnishments (court-ordered withholdings)

Employees can have their wages withheld (or “garnished”) by court order to fulfill bad debts, alimony, or child support payments, and it’s the employer’s responsibility to withhold these funds. These are known as involuntary deductions. Because of the burden to employers, some court orders will include a small fee to be withheld from the employee to reimburse you for your administrative costs.

A wage garnishment is a legal procedure, so be diligent and careful if you have employees whose wages are being garnished. There can be penalties if you don’t respond to a wage garnishment letter or court order in a timely manner.

After-tax paycheck deductions

Paycheck deductions taken out after tax is deducted are known as voluntary deductions. These include health insurance, dental insurance, retirement contributions, union dues, charitable donations, and contributions to 529 college savings plans.

6. Add reimbursements back in

Paychecks get smaller and smaller with each deduction and tax withholding, but there is one place they can get bigger. That’s through any reimbursements for work-related expenses a teammate has incurred.

Did your employee do something like drive to visit a client (mileage reimbursement), buy lunch for the team, or sign up for a conference with their own credit card? Then you might owe them some money.

Reimbursements are added in after taxes because they’re not really income an employee has earned. Remember that reimbursements are usually deductible business expenses for your company, so you’ll want to keep track of them for your own tax filings.

7. Calculate their paycheck!

You’re this close to calculating how much your employee’s paycheck will be after taxes.

Once you’ve got all of the paycheck’s line items figured out, all you have to do is add (or subtract) them up using the following formula:

Gross pay – Taxes – Deductions + Reimbursements = Net pay

The number you’ll get at the end (the net pay) is what your employee will actually receive in their paycheck or how much they’ll make after taxes.

To make things even easier, check out these calculators:

8. Issue paychecks

The final step in the process is to ensure the paychecks get into employees’ hands. It’s common to use physical paychecks and issue them within your place of business. But, it’s often easier and more efficient to pay employees via direct deposit.

This puts the money straight into the employee’s bank account. The employee should also receive a pay stub that shows their gross earnings and deductions.

Calculating payroll: frequently asked questions

Who pays unemployment taxes?

In most cases, employers pay both a Federal and a state unemployment tax. These taxes contribute to the Federal Unemployment Tax Act (FUTA) and state unemployment systems, which provide benefits to people who have lost their jobs.

Is it easy to learn how to do payroll?

The payroll process can be tricky at first, but many business owners manage to run payroll on their own. They often use payroll software or a paycheck calculator as part of their payroll system. However, working with a payroll service like Gusto can be beneficial, saving you time and ensuring you’re always in compliance.

How do I calculate payroll for salaried employees?

To calculate the payroll of a salaried employee, you’ll divide the annual salary by the number of payrolls in a year. For example, an employee who earns $60,000 a year and is paid semi-monthly (24 payrolls), earns a gross paycheck amount of $2,500.

After calculating the gross amount, you’ll still need to make all applicable deductions, including

  • Federal income tax
  • State income tax
  • Local income tax
  • FICA
  • Voluntary deductions
  • Involuntary deductions
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