A 2021 Guide to Payroll: How Are the Calculations Done?

When businesses hire employees, it is their responsibility to calculate their payroll every month, including their net salary and deductions employees are liable for including taxes and voluntary deductions. 

Companies must get their employees’ payroll correct as mistakes can result in overpayment or underpayment of income tax, Social Security, or Medicare which may lead to problems when employees are filing their annual taxes.

Furthermore, payroll miscalculations can attract the attention of the Inland Revenue Service, and if their review finds any discrepancies that break tax laws then a fine will be applied. 

Correctly calculating payroll is vital to keeping staff happy, effective record keeping and complying with tax regulations, therefore this article provides a guide to help any new or existing businesses looking to shore up their payroll system by ensuring calculations are correct. 

Make Sure Employees Complete Their Forms

As part of their onboarding process, employers must request that new staff complete a W-4 form otherwise known as an Employee Withholding Allowance Certificate.

The accurate and timely completion of this form is an essential first step in the calculation of payroll as it informs a company’s payroll team of the amount of federal and state income taxes to withhold from an employee’s paycheck.

Once employees have filled in their W-4 forms, payroll managers should carefully check them to make sure the numbers for each deduction are correct and the employee has filled out all the necessary information correctly. 

Checking that employees have accurately filled out their forms will save a company and its employees from having to resubmit applications for their tax certificates.

The main sections of a W-4 form are designed to record an employee’s details, Social Security number, filing status (single or married), dependents such as a spouse and children, and income.

Employees should also write down income from sources other than employment such as income from investments.

Calculate Employees’ Gross Pay 

Before an employee’s final payroll can be calculated, their gross income must first be ascertained, this is done by multiplying the hours an employee worked over a certain period of time by the agreed hourly rate set out in the employment contract.

Alternatively, an employee may be paid a fixed salary which requires no calculation unless bonuses or overtime fees are paid.

 An employee’s payroll should detail their total income over a set pay period which could be weekly, bi-weekly or monthly, additional income may come from bonuses, commission, and overtime. 

Check Income Tax Tables

Each employee will be liable for different tax deductions based on their specific circumstances related to exemptions, filing status, and level of income.

Subsequently, payroll staff needs to look on the Inland Revenue Service website to find which tax rules apply in order to calculate the amount of tax an employee must pay. 

Apply Taxes to Withhold

Using the federal tax tables, businesses can deduct the accurate amount of tax to withhold for payment to the IRS.

The withholding figure an employee must pay is based on their gross pay and the number of tax exemptions they claim, the final total of tax due is then deducted from an employee’s gross pay. 

Other taxes that a company may need to withhold on the behalf of their employees are Social Security taxes, the amount an employee is liable to pay is simply calculated as a fixed percentage of gross pay, which currently stands at 6.2%.

Additionally, both the employer and employees may also have to make Medicare contributions of 1.45% of gross pay each. 

Minus Other Deductions

In addition to being legally required to pay federal taxes, Social Security, and Medicare, employees may also choose to make certain voluntary contributions such as retirement funds, health insurance premiums, life insurance, retirement plans, and 401(k) plans.

On the other hand, employees could be liable to pay further mandatory deductions, some examples include alimony and child support. 

Confirm Net Pay 

To finalize an employee’s payroll, a business must calculate the net pay by subtracting the total taxes and deductions from the total income.

Once all the calculations are complete it is considered best practice to review all the details and check over the math’s at least a few times. 

Use Payroll Management Software 

Many businesses, large or small, opt to use payroll management software to digitize records and automate certain processes including:

Calculating employees’ payroll is an important responsibility that every company must take seriously if they want to keep their workforce happy and remain compliant with labor and tax laws.

Therefore, it is a smart move for businesses that are reviewing their payroll to be familiar with the steps and considerations to calculate payroll correctly.