Payroll expenses: How to calculate them + examples

Growing your business can take many forms, but the bigger you get, the more likely you are to need to hire new employees. For nearly 26% of business owners surveyed, hiring new or additional employees is a major priority for 2025. 

And payroll expenses can increase with every employee you add to your business. But what exactly are payroll expenses, and when are they incurred?

Follow this small business payroll expenses guide to learn the answer to these questions and how to calculate your total payroll costs for hassle-free bookkeeping.

Jump to:

• How do payroll expenses work
• Examples of payroll expenses for employers
• Payroll expenses for independent contractors
• How to calculate payroll taxes
• How the accrual method helps with payroll expenses
• Next steps for streamlining your payroll process
• Payroll expense FAQ

How do payroll expenses work

Payroll expenses are what employers pay to hire workers. To pay workers, start with gross pay and deduct withholdings to calculate net pay. Processing payroll requires collecting and managing data, and your payroll expenses may change frequently.

Examples of payroll expenses for employers

Most businesses will have to cover several types of payroll expenses for their employees. While the expenses you’ll be responsible for will depend on your company’s structure, you can typically expect to pay the following:

Gross wages

Calculate gross wages from an annual salary or hourly pay rate and hours worked. You’ll want to do this for every employee you pay, regardless of their role in your company. 

The gross wages you pay employees may be your largest payroll expense. This is normal and shouldn’t cause alarm for most businesses.

Deductions for state and federal income tax withholdings

You must deduct federal—and possibly local and state payroll taxes, income taxes from wages. The worker’s annual income and the number of allowances they specify on their W-4 determine the amount you deduct. Pass what you withhold to each taxing authority. These amounts aren’t employer expenses.

Deductions for FICA taxes

FICA taxes fund Medicare and Social Security. Currently, employers pay a 6.2% Social Security tax and a 1.45% Medicare tax (7.65% in total). Each worker pays the same 7.65% tax through payroll withholdings. 

Unemployment tax (FUTA and SUTA) withholdings

The Federal Unemployment Tax Act (FUTA) and the State Unemployment Tax Act (SUTA) provide temporary income for workers who lose employment. 

The current employer’s FUTA tax rate is 6% on the first $7,000 in gross income a worker earns. If wages are subject to a state unemployment tax, the employer can use a 5.4% FUTA credit, which reduces the FUTA tax to 0.6%. Total federal and state unemployment taxes vary and depend on each state’s unemployment program. 

Benefit withholdings

If your company offers benefits, you may withhold a portion of the costs from a worker’s pay. 

For example, you may withhold amounts for the employee’s share of insurance premiums or their retirement contributions. Your share of the costs is a payroll expense. Generally, the only payroll cost for an independent contractor or freelancer is the dollar amount you pay for services. 

Some of the most common employee benefits include:

• Health care coverage (health insurance, dental, vision, etc.)
• Paid leave (PTO and sick days)
• 401(k) plans
• Life insurance

Payroll expenses for independent contractors

A worker’s classification determines how you treat them for tax purposes. If the worker is an employee, you’ll incur the cost of payroll discussed above. Independent contractors or 1099 employees, on the other hand, are responsible for all tax withholdings. The company’s only expense is the gross amount you pay for services.

The IRS explains how to assign workers to a particular category. The control you have over a worker determines if the worker is an employee or an independent contractor. 

The guidelines consider how much control you have over what the worker does, who provides tools and supplies, and if you have a written contract. If you have a lot of control over a worker, you should classify them as an employee.

How to calculate payroll taxes

To calculate your total payroll tax liability, you’ll need to collect information, perform calculations, pay workers, and submit withheld payments to third parties.

1. Collect information on Form W-4 

New employees must complete Form W-4. The form tells employers how much to withhold from a paycheck for tax purposes. The number of allowances on the W-4, along with the gross pay, determines the tax withholdings.

The W-4 also guides employees who have multiple jobs or spouses who work. There are extra schedules to calculate withholdings in these situations. 

2. Use the payroll cycle to determine gross pay

Gross wages are the starting point for payroll. The number of pay periods per year determines how much of a worker’s salary you pay on each payroll date. If you pay an employee hourly, the pay period indicates the start and end dates for payroll.

3. Calculate net pay for your employees

Net pay is the amount the worker receives after all payroll deductions and withholdings. To figure out your employee’s net pay, you’ll need to subtract the tax deductions you withhold from their paychecks from their gross pay (their salary or wages before deductions).

You’ll want to subtract withholdings such as:

• Income taxes
• FICA taxes
• Health insurance premiums

Say an employee’s annual gross pay is $60,000. Their gross pay per period is $2,308. Then, you deduct 20% for federal income taxes and 5% for state income taxes. You deduct another 7.65% for FICA taxes and $50 for the employee’s health insurance. So, the employee’s net pay for the pay period is $1,504. 

4. Submit payroll tax deposits

Business owners must submit deposits for tax withholdings. The deposit frequency varies and depends on the dollar amount. Submit payroll tax deposits for federal and state income taxes and FICA and FUTA taxes. You can pay tax deposits online, making it easier to submit them on time.

5. Complete payroll tax forms

Payroll tax returns are complex, so the information you submit must be accurate. Make sure to submit the forms before the appropriate tax dates and deadlines to avoid late fees. There are four common payroll tax forms. Payroll software can generate these reports automatically.

1. Form 941 reports federal income taxes and FICA taxes to the IRS each quarter.
2. Form 940 is your annual federal unemployment (FUTA) tax return.
3. Form W-3 reports the total wages and tax withholdings for each employee. File this form with the Social Security Administration annually.
4. Form 1096 reports the dollars you paid to independent contractors using 1099 forms. File this form annually. 

6. Report pay amounts to workers 

Business owners issue Form 1099-NEC to independent contractors. You must issue a 1099-K form to each contractor who makes $600 or more from your business during the calendar year. If they make less than $600 from your business, the earnings are still taxable, so the contractor should report them on their tax return. Employees receive a W-2, which reports gross pay and all tax withholdings for the year. 

7. Keep records on file 

The Fair Labor Standards Act (FLSA) requires businesses to maintain employee time tracking and pay records for at least two years. Changes to tax laws, adding or losing employees, and changes to tax withholdings may affect your total payroll costs from one pay period to the next.

How the accrual method helps with payroll expenses

Payroll expenses are incurred on the day the employee works and earns their pay. Because of this, every business should use the accrual method of accounting, which matches the revenue it earns with the expenses it incurs. 

The accrual method records payroll expenses in the month that you incur them, regardless of when you pay for the expenses. The matching concept presents a more accurate picture of company profit. This accounting method does not post expenses based on cash outflows.

How accrual accounting works in real life

Assume that a restaurant owes workers $3,000 in payroll for the last five days of March and that the next payroll date is April 5. Using the accrual method, the $3,000 wage expense posts on March 31, along with a $3,000 increase in wages payable.

When the business owner processes payroll on April 5, cash decreases by $3,000, and wages payable decrease by $3,000. The expense posts in March when employees worked those hours. So, March revenue matches March expenses, including the $3,000 payroll costs.

Meanwhile, the accrual method posts payroll liabilities and expenses in the same period. The restaurant example shows a $3,000 wage expense and a $3,000 wage liability balance from March 31. When the business owner pays cash on April 5, the liability balance will decrease.

Next steps for streamlining your payroll process

Processing payroll requires a company to complete several steps and calculate withholdings for employees. For many business owners, calculating those payments and withholdings takes time and can make running the rest of the business more difficult. 

Use payroll software to process payroll and avoid manual calculations. Payroll can change frequently, so document your payroll process to save time.