In the last post, Introduction to Payroll, we went over the paystub, your W4 and what it all means. In this post we’re going to put that information together with the Federal Employer’s Tax Guide Publication 15 and the Federal Income Tax Withholding Methods Publication 15-T and calculate a sample paycheck (or at least the Federal part). Feel free to download those guides and the W4 so you can follow along.
Table of Contents
Gathering Employee Information
The first thing you’ll need to do to start a paycheck is make sure you’ve gathered all the information for the employee. If that’s you, it should be pretty easy. Aside from the pay rate and hours worked if applicable, everything you need is on the W4 form so let’s take a look at it.
The W4 is actually laid out pretty well. In Step 1 you’re going to enter your name and address information including your Social Security number on cell (b). If you use the wrong Social Security number then someone else will get your benefits when you retire, so don’t do that. Cell (c) is also extremely important as this is your filing status and is directly used by payroll calculations for income withholding. You can choose whether you’re single, married or head of household and the calculations attempt to hold back the right amount of taxes from your paycheck for you.
In Step 2 they want you to check the box if you have multiple jobs or a spouse that works at a job with a similar size paycheck as your own. If your spouse’s job is paying less than half of what your paycheck is you probably don’t need to check this.
Step 3 is where you claim your dependents. This used to be very complicated prior to the changes made to the W4 in 2019, but now it’s pretty simple. If your total income will be $200,000 or less (or $400,000 if you’re married), you multiply the number of qualifying children under the age of 17 by $2,000. The bottom line is if you have kids, then each kid is worth two grand on this sheet. For example I’ve got three kids under 17 and would put $6,000 on that line. If you have other dependents, like a grandparent or somebody else you’re supporting you can put that on the next line at $500/each and then you add the amounts and put them on line 3.
Step 4 goes through other income, deductions you might have and any extra that you might want held back from each paycheck. The reality is most people don’t fill in this section and most people probably shouldn’t. Chances are good that as a solopreneur or small company your taxes are not going to be correct in your 1st year of payroll anyway, so just do your best with this form, and next year make adjustments.
For Step 5 sign it, date it and fill out the employer information including the EIN number. Armed with your W4 and the two Federal publications, 15 and 15-T, you’re ready to start your first paycheck.
Getting Paid – How Often and How Much?
The first things you’ll need to decide are how often you’re going to do payroll and how much you’re paying. How often defines your “pay period”, or the standard length between paychecks. This frequency affects your tax withholding and is used in the calculations. If you write an annual check for $1,000 then you’re below the poverty line and you probably won’t have any income tax withheld, but if it’s a weekly check then $52,000 for the year means you probably have to pay income tax. The possible choices are in the table below:
|Pay Periods per Year
|Once a week
|Every two weeks
|Twice a month
|Once a month
|Once every 3 months
|Once every 6 months
|Once a year
|Daily or Miscellaneous
|Whenever you want to
Once you’ve figured out how often you need to decide how much. That’s pretty obvious I’d think – I mean you want to write your paycheck for some amount over zero right? But there are a few details you may need to iron out first, like are you salaried or hourly? Are you exempt from overtime or not? Or do you want to randomly write yourself a paycheck for whatever amount you want when the money comes in?
If you’re salaried there’s an easy way to to figure out your paycheck amount – just divide your annual salary by the number of pay periods in the year (see the chart above for pay periods). If you’re hourly then how many hours did you work this pay period? Just multiply your hourly wage by the number of hours worked. If you’re exempt from overtime then any hours over 40/week just get multiplied by your normal hourly wage, but if you’re not exempt then any hours over 40/week get multiplied by 1.5 times your normal hourly wage, or in some cases 2 times your normal hourly wage.
As the business owner I’m going to assume you’re exempt and probably either have a salary or just pay yourself as the money comes in. For the purposes of this article we’ll say that you plan to pay yourself semi-monthly (24 pay periods) at $5,000.00 per paycheck which comes out to $120,000 salary per year.
Figuring Your Federal Taxes
Remember from our pay stub in the last lesson we had lines for income taxes withheld, Medicare and Social Security. What isn’t shown on the pay stub is the employer side of those taxes, comprised of Medicare, Social Security and Unemployment Tax, also known as FUTA after the Federal Unemployment Tax Act. The employee taxes are withheld from the paycheck and the employer side is paid directly by the employer.
How much to set aside for taxes is laid out in the two federal publications, 15 and 15-T. Payroll can be a very complex topic and if you read through those publications at all you can see that there are edge cases that most people will probably never hear about. Keep in mind that those publications have to cover everything, but your taxes as a small business owner are probably going to be a LOT simpler – especially for your own paycheck. Thus I’m just going to be going through the basic normal case here. If you need to get off into the weeds those publications will guide you.
Social Security Taxes
I’m going to start with Social Security since it’s the easiest of the taxes to calculate. In the most recent Pub 15 I have (2023) Section 9 goes through all the withholding rules and Social Security is among them. This tax has two components to it: the wage base limit and the rate.
The wage base limit is the maximum wage subject to the tax for the year. For 2023 that limit is $160,200, so any wages over that amount are not subject to the Social Security tax. The tax rate is 6.2% each for the employee and employer, so for our first $5,000 paycheck it would look like this:
- Employee SS: $5,000 x 6.2% = $310.00
- Employer SS: $5,000 x 6.2% = $310.00
Make sure you keep track of the year-to-date (YTD) wages so you know when you hit the wage base limit ($160,200) to stop withholding. For our example here of an annual salary of $120,000 it won’t be hit at all.
The Medicare tax rate is 1.45% each for the employee and employer. Medicare doesn’t have a wage base limit so all wages are subject to this tax. However Medicare does have an additional tax of 0.9% on the employee for all wages over $200,000. For our first $5,000 paycheck it would look like this:
- Employee Medicare: $5,000 x 1.45% = $72.50
- Employee Additional: $0.00 x 1.45% = $0.00 (amount over $200,000 is $0.00 so far…)
- Employer Medicare: $5,000 x 1.45% = $72.50
Again make sure you keep track of the YTD wages so you know when the additional Medicare tax of 0.9% kicks in at $200,000 (which it won’t in our $120,000 annual example).
Income Tax Withholding
Income tax is the most complicated of the taxes but typically the largest chunk. Luckily it’s an employee tax only, but since you’re writing your own paycheck that still means you. There isn’t a simple rate you can use but instead a complex series of tables and conditions to follow in Pub 15-T. It’s so confusing in fact that based on when the W4 was last filled out and several other factors there are no less than 7 different ways to calculate it.
It’s enough to make your head spin.
For the typical employee in 2023 or later I suggest you go with Method 1. Percentage Method Tables for Automated Payroll Systems. It’s actually the least complicated and only involves a single confusing table instead of pages and pages of them. As long as you have a W4 from 2020 or later you can use it.
We’ll get to the table in a minute, but let’s look at Method 1’s worksheet first. Calculating your federal income tax withholding is really as simple as gathering your starting information from the W4 and salary and then just following Worksheet 1A. Go ahead and read through the lines on the image below that have a value I’ve filled in. The blank lines can be ignored for now.
Step 2b in the worksheet is where the single confusing table comes into play. I’ve copied the table below and I’ve highlighted the row that matches our $5,000 semi-monthly paycheck. 2a has a value of $107,100 which is over $104,250 and less than the line under it of $205,550, so I’ve highlighted the row with $104,250. That gives us a base tax of $10,294 and 22% of anything over $104,250 up to our $107,100 adjusted annual wage (or 22% of $2,850).
Does that make sense? It can be kind of confusing.
Employer FUTA Tax
Remember that the employer, you, has to pay the other half of Social Security and Medicare and we’ve already listed out those calculations above. The employer also has an additional small tax to pay for unemployment purposes commonly just called the FUTA tax.
The FUTA tax can be found in Publication 15 section 14 and as of 2023 is 6% of the first $7,000 in wages per employee ($420.00). That sounds pretty straightforward right? For our initial $5,000 paycheck that would be:
- Employer FUTA: $5,000 x 6% = $300.00
But of course there is a caveat. You can take a maximum credit of 5.4% if you pay into your state unemployment fund. Most states have this and require it so it’s a good thing for your pocketbook that the feds allow this. Here in California new employers are assigned an unemployment insurance rate of 3.4% for the first 2-3 years. After that it is adjusted based on your rating and the balance in the state UI fund and you’ll get a letter every year with your rate information.
Let’s assume for this example that you’re new and it’s set at 3.4%. How does that work for your FUTA? You simply subtract the state rate (up to the maximum credit of 5.4%) from the FUTA rate (6.0% – 3.4%) to come up with your adjusted federal rate of 2.6%.
- Actual Employer FUTA: $5,000 x 2.6% = $130.00
What happens to the other 3.4%? You’ll pay it to the state when we calculate the state tax liabilities in the next article.
Federal Paycheck Summary
So far your paystub for your $5,000 paycheck looks like this:
I’ve left out the California numbers and will go through those in the next article. If you’re in a state with no taxes then what’s here may be all you need, though don’t forget to track the employer specific taxes also. Your actual payout (so far) on a $5,000 paycheck is:
- Net Pay to Employee: $4,412.46
- Taxes withheld from paycheck: $587.54
- Employer Medicare: $72.50
- Employer Social Security: $310.00
- Employer FUTA: $130.00
When you add those up your first $5,000 paycheck actually costs the business $5,512.50. And that’s before we add in state taxes.
Payroll tax laws and regulations may also change, so it’s important to stay updated with the latest information from federal and state tax authorities. This level of complexity is why most businesses don’t bother with it every year and hire a payroll company to do it for them, or worse – they stay a Sole Proprietorship where payroll for a solopreneur isn’t needed and miss out on the extra income that would bring.
cheap frugal, but since I’m a software developer I just wrote my own payroll program that tracks everything for me. It wasn’t easier I have to admit and there’s still a bit of annual maintenance but I’ve enjoyed it. What can I say? I have a twisted sense of fun and I’ve been doing my own payroll since 2016.
I’ve actually been working on making it available to other small businesses and if you’re interested in joining the beta program when it’s published go ahead and sign up for my mailing list and you’ll be the first to hear when it’s ready for you. If you can’t wait there are some other really good payroll companies out there that would love to have your business.
Anyway if you’d like to see how to calculate the California State payroll taxes then check out my next article where I’ll go over that very thing.