Manually Calculate Payroll Checks

For most small business owners, outsourcing payroll to a payroll software company like Gusto is going to be a huge time saver for calculating paychecks. However, I do believe that it is important for you to understand what goes into calculating payroll checks in case you ever need to do it manually or to correct a payroll error. Let’s walk through the components of the formula and then use an example so that you can see how to do the calculation.

Below is the formula to calculate net pay for an employee along with a brief description:

Net Pay = Employee Gross Pay – (Employee Share of Social Security + Medicare + Federal Withholding Tax + Other Deductions)

Gross Pay

Gross pay is the salary/wage paid to an employee each pay period. The formula to calculate gross pay for hourly and salaried employees is as follows:

• Hourly employee: Hours worked x Hourly rate
• Salaried employee: Annual salary / Total number of pay periods

Social Security Tax

As an employer, you are required to withhold 6.2% of an employee’s gross pay for Social Security. You are also required to match the 6.2% employee contribution. Here is the formula to calculate the employee’s share of Social Security taxes:

• Gross pay x 0.062

Medicare Tax

You are required to withhold 1.45% of an employee’s gross pay for the Medicare fund. Similar to Social Security, you are required to match the 1.45% employee contribution. Here is the formula to calculate the employee’s share of Medicare taxes:

• Gross pay x 0.0145

Federal Withholding

Federal withholding is the amount of income tax that an employee must pay, based on their gross pay, tax bracket, number of allowances claimed on Form W-4, and their marital status. With this information, you can look up the federal withholding amount for employees by using the IRS Tables in Publication 15.

To see how this works, let’s walk through an example:

Federal Withholding Example

In this example, let’s assume our employee is married and has claimed two allowances on her W-4 form. She is paid $1,600 per pay period. Assuming we run payroll on a biweekly basis, we would use the following wage bracket table (from IRS Publication 15) to determine the amount of income tax to withhold. Based on this table, we would withhold $109 from this employee’s paycheck for income tax.

Other Deductions

Depending on what fringe benefits you offer, there may be several deductions that you need to make for employee paychecks besides Social Security, Medicare, and federal withholding. For example, if you offer a health insurance plan that the employee can contribute to, you will need to deduct the employee’s share of that health insurance plan in order to calculate net pay.

Putting It All Together

Now that you are more familiar with the components of calculating net pay for your employees, let’s walk through an example. We will assume the employee makes $20 per hour and worked 80 hours this pay period.

The six steps to calculate net pay for an employee paycheck are:

Calculate Net Pay for Employee Example

1. Calculate Gross Wages	80 hours X $20 = $1600
2. Calculate Federal Income Tax Withholding (from previous example)	$109
3. Calculate Social Security Tax	$1,600 X 0.062 (6.2%) = $99.20
4. Calculate Medicare Tax	$1,600 X 0.0145 = $23.20
5. Subtotal all deductions (steps 2, 3, 4)	$109 + $99.20 + $23.20 = $231.40
6. Subtract subtotal of all deductions from Gross Pay to get Net Pay	$1,600 - $231.40 = $1,368.60 (Net Pay)