Ensuring your employees are paid accurately and on time is one of the most important tasks when running a small business. However, calculating employee wages for the first time can be confusing.
There are many factors that affect your employee’s final take-home pay and plenty of legal regulations to keep up with. In this post, we’ll walk you through how to calculate an employee paycheck from start to finish.
Read the post in full or navigate to your preferred section using the links below:
- How to calculate an employee paycheck
- What you need to manually calculate a paycheck
- Step-by-step guide: How to calculate an employee’s paycheck
Manually calculating your employee’s take-home pay requires a good deal of math and a whole lot of organization.
While there are plenty of considerations to keep in mind when calculating an employee paycheck, you can begin by using this basic employee paycheck formula as a guide.
Pro Tip: Check out our Paycheck Calculator to calculate pay and withholdings within seconds.
Net pay = Gross pay – Pre-taxes – Employee taxes – Post-tax deductions + Reimbursements
To calculate employee paychecks, you’ll need an array of information, including
- Employee salary or hourly rate
- Federal, state, and local tax rates
- Retirement contributions information
- Employee deduction information
- Employee reimbursement information
We’ll go over how this information comes into play as you calculate an employee’s paycheck in our step-by-step guide below.
There are five key steps to manually calculating your employee’s take-home pay, beginning with examining their gross earnings.
Step 1: Calculate your employee’s gross pay
Typically, an employee paycheck begins with an employee’s gross wages: the total amount of money your employee has earned during the specified pay period.
To determine gross pay, you must consider their type of employment, salaried or hourly.
Gross pay for salaried employees: When calculating a salaried employee’s paycheck, gross earnings are their annual salary divided by the number of pay periods in the year. If your salaried employee makes $60,000 per year, and you pay your employees twice per month, their gross pay for a given pay period would look as follows:
Gross wages (salaried employee): Annual salary ÷ pay periods
$2,500 = $60,000 ÷ 24
Gross pay for hourly employees: When calculating the paycheck of an hourly employee, gross wages refers to the number of hours they worked multiplied by their hourly pay rate. If your hourly employee makes $16 per hour, and they worked 32 hours in the specified pay period, their gross pay for the given pay period would look as follows:
Gross wages (hourly employee): Hours worked within pay period x Hourly rate
$512 = 32 x $16
When determining gross wages, employers must also consider tips, commission, and overtime. Overtime can complicate the process of calculating an employee’s paycheck.
If your hourly employees work over 40 hours in a week, you are required to pay overtime. Most salaried employees are exempt from overtime, but this is dependent on pay level.
Employers may elect to pay more than the federally required overtime rate, and some states actually have additional overtime laws requiring overtime be paid at a higher rate than required on the federal level.
Let’s take our hourly example from above.
If your employee makes $16 an hour and works 45 hours in a single week, they are entitled to receive overtime pay for 5 hours at 1.5 times their hourly rate. The gross pay formula would be as follows:
Gross pay per week (hourly employee with overtime):
Hours worked/week x Hourly rate – (Hours worked above 40 x [hourly rate x 1.5])
$632 = (40 x $16) + (5 x [16 x 1.5])
Step 2: Take out elective pre-tax withholdings
Employees may elect to have some amounts withheld from their paychecks on a pre-tax basis. These are referred to as pre-tax withholdings or pre-tax deductions.
These deductions are premiums paid toward benefits. Employees who request these deductions lower their taxable wages, meaning they will owe less federal income tax and Federal Insurance Contributions Act (FICA) tax, which includes Social Security and Medicare taxes.
As an employer, you will withdraw money directly from your employee’s paycheck to cover the cost of these benefits, deducting this amount from their gross income before taxes. Pre-tax withholdings can also reduce the amount your small business owes on payroll taxes.
What are common pre-tax withholdings?
- Childcare assistance
- Retirement contributions
- Health care deductions
- Health insurance
If an employee’s benefits are paid with pre-tax deductions, they cannot claim those deductions on their income tax return.
Step 3: Deduct employee taxes
Once you’ve taken pre-tax withholdings from your employee’s gross pay, you need to deduct employee taxes.
As an employer, you are responsible for withholding payroll taxes from your employee’s paycheck, including
- FICA taxes: Social Security tax and Medicare tax
- Federal unemployment taxes (FUTA)
- State unemployment taxes (SUTA)
- Local income taxes
Some paycheck deductions only affect your employees, Your responsibility as their employer is to withhold the appropriate amount of funds, then remit them to the IRS on behalf of your employee. This is a key component of the small business payroll process.
Employee-only taxes include
- Federal income tax: To determine your employee’s federal income tax deduction, you must consider their taxable gross wages, their marital status, and the number of allowances they’ve claimed on their W-4 form. With this information, you can use IRS Publication 15 (Circular E) to determine the required federal withholding amount.
- State tax: The majority of states have state income tax, but these rates can vary significantly, so be sure to examine the income tax brackets in your area. If your business operates in a state that requires employees to contribute to State Disability Insurance (SDI), you’ll need to subtract that amount as well.
- Local tax: Some cities require deductions from employee paychecks. These rules can vary depending on the city in which you operate and the city in which your employee lives, so pay close attention if your team is composed of remote employees.
While employers are not required to pay into the above taxes, there are certain paycheck deductions that require payment from both employee and employer.
- FICA taxes: Employers and employees must contribute 6.2% of an employee’s gross income to Social Security tax. Additionally, employers and employees must contribute 1.45% of the employee’s gross income toward Medicare.
Step 4: Take out voluntary and involuntary deductions
In addition to the taxes discussed above, there are voluntary and involuntary deductions that you may be required to withhold from an employee’s paycheck.
Examples of involuntary (mandatory) deductions:
- Court-ordered child support payments: If your employee is required to contribute a certain amount of their paycheck to child support payments, you may need to withhold these funds.
- Wage garnishments: If your employee is required by court order to pay off tax debt, it is your responsibility to withhold the appropriate amount.
Voluntary deductions require written employee authorization before the deduction can be taken. Examples of voluntary deductions:
- Uniform or tool expenses
- Tuition or certification expenses
- Health insurance premiums for a medical, vision, or dental plan
Step 5: Add reimbursements
You may need to add money to your employee’s paycheck if they qualify for reimbursement. If one of your employees has incurred a qualified, work-related expense, you may need to pay them back.
Examples of employee reimbursements may include:
- Mileage reimbursements: If your employee had to drive to a client meeting, you may reimburse them for the money spent on gas.
- Food reimbursements: If a manager on your team buys meals for their direct reports, you may pay them back for that cost.
Common issues employers face when manually calculating paychecks
Manually calculating employee paychecks can be challenging, and employers run into many issues.
These issues may include:
- Disorganized or missing employee information
- Confusion regarding state, federal, and local taxes
- Confusion regarding FICA and additional taxes
- Missing deductions or reimbursements
There’s a lot to keep track of, and small mistakes made when calculating your employee’s paychecks can have lasting consequences. Employee retention rates may suffer if your team isn’t paid on time or paid accurately, and legal consequences can result from miscalculated payroll taxes.
Streamlining your paycheck process: The benefits of using payroll software
Manual calculation requires plenty of time, patience, and organization. While calculating your team’s paychecks manually may work at the onset of your business, many business owners find the process can quickly grow too complex and time-consuming.
Here are a few of the benefits of calculating employee paychecks using payroll software:
- Improved organization: Payroll software is designed to compile all necessary employee data into a single central location. That means you have all the pieces of information you need in one place.
- Automated payroll processing: Business owners have plenty on their plate, and payroll software automates the tasks of running payroll and sending out checks every pay period. Once your payroll is set up, you can sit back with peace of mind, knowing your team is getting paid on time, every time.
- Expert setup: Instead of going it alone with manual calculation, business owners can leverage the expert advice of payroll experts. Payroll experts can set up employee information and payroll processes for you.That way, you know all is done in accordance with local, state, and federal regulations from the start.
- Paycheck flexibility: With payroll software, you have the ability to print checks or use direct deposit for your employees, allowing improved flexibility.
- Customer support: When questions arise, dedicated payroll software provides access to experts that can help you navigate the payroll process.
- Tax penalty forgiveness: Payroll software comes with tax-penalty protection, giving you peace of mind that your payroll is done correctly.
- Time saved: Automating your payroll processes allows you to get back to what you do best—building your business.
Calculating employee paychecks can be a complex process, but with improved organization and a dedicated payroll service, you can streamline your efforts and ensure your employees are paid on time, every time.
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