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As a small business owner, you’re definitely not alone if you’re having a hard time figuring out payroll tax withholding. It’s complex and it can feel very overwhelming, but we’re here to help you check off the seven things you have to do before writing your employees’ paychecks.
Let’s start at the top: What is withholding?
The IRS requires any business with employees to withhold certain taxes from employees’ paychecks, then deposit them with state and federal entities. Federal withholding rates can vary from employee to employee based on the information provided on their W-4 (more on that later), but the FICA taxes for Social Security and Medicare are calculated using a set formula for all staffers. So, the first step for you is to get the employee-specific withholding information you need.
Before you dive in, remember that only about 40% of small business owners handle payroll (and all the withholding, deductions, and tax filings) by themselves. Business owners who rely on a payroll service save an average of 15 hours a month, so there’s a large chunk of time you could be taking advantage of when working with a solution provider. If you think you could use help, here’s a checklist you can use when choosing between payroll solutions.
And if you’re curious what businesses are saying about working with us, read OnPay reviews from customers that use our tools to handle payroll.
Step 1: All new employees need to fill out a W-4 on their first day of work
You must receive a completed W-4 form from each employee before payroll is processed so that the correct amount of federal tax is withheld from their paycheck. Complete instructions are included with the form, including guidance for those with multiple jobs or a working spouse.
A W-4 should be filled out by all employees when they are hired, or whenever their life or financial situation changes.
In 2020, the W-4 was revised. The new form has a five-step process and new Publication 15-T (Federal Income Tax Withholding Methods) for determining employee withholding. It no longer uses withholding allowances.
If your employee was hired in 2019 or prior, you can continue to use the information they provided on the old W-4. It includes a worksheet that allows your employees to calculate withholding allowances for dependents and children. Some employees may want to fill out a new W-4 if they work a second job, get married, have a child, or get divorced.
Don’t forget! Hang onto those W-4s — or W-9s
A completed W-4 must be kept on file for all employees. They do not expire, however, employees can choose to update their information at any time. It’s important to note that only employees are required to fill out a W-4. Anyone hired as a contractor should fill out Form W-9 to ensure that you have the information needed to process their 1099 at the end of the year.
Step 2: Determine gross pay
Next, you’ll calculate the employee’s gross wages before determining the amount of taxes that should be withheld.
For hourly employees:
- Calculate employee base pay by the number of hours worked. For example, 80 hours x $10.00 per hour would be $800.00.
- Overtime hours are typically calculated at time and a half, so five hours of overtime would be calculated as 5 x $10.00 x 1.5 = $75.00. For an employee who works 80 hours, plus five hours of overtime at $10 per hour, that would make their gross pay: $800.00 + $75.00 = $875.00.
For salaried employees:
- Salaried employees are paid the same each pay period. For a twice-monthly pay period, an employee making $40,000 a year would receive $40,000, divided by 24 annual pay periods, making their gross wages for the pay period $1,666.67.
Step 3: Calculate federal withholding based on gross pay
Once you have an employee’s gross pay calculated, you can then determine federal withholding. Here’s where that W-4 comes into play: You’ll look at the withholdings they chose, including any additional taxes that they asked to be deducted.
You’ll need to access the IRS tax tables for 2024 in order to calculate everything accurately, or you can use trusted payroll software or a payroll calculator to do the math for you.
Step 4: Calculate FICA contributions
Next, you’ll calculate FICA payroll taxes. FICA is a combination of Social Security and Medicare, and both the employer and the employee contribute to them. You will withhold a total of 7.65 percent, including 6.2 percent for Social Security and 1.45 percent for Medicare. Please note, employers must withhold Social Security taxes until the employee earns at least $168,600 in 2024 (which is up from $160,200 in 2023). There is no income limitation for Medicare taxes.
To calculate FICA, use the following for hourly or salaried employees:
- For gross pay of $875.00, multiply 875 x 6.2% = $54.25 for Social Security tax
- For Medicare tax, multiply $875.00 x 1.45% = $12.69
- The total FICA to be withheld for this pay period is $54.25 + $12.69 = $66.94
In addition to Social Security and Medicare taxes, employees who earn in excess of $200,000 annually will also pay a 0.9 percent Medicare surtax, which will be withheld from their checks in addition to the other FICA taxes.
Step 5: Match employee contributions for FICA
In addition to withholding FICA taxes from employee wages, employers are also responsible for matching the amount of FICA taxes withheld, so if $66.94 was deducted from your employee, you’ll need to match that amount and deposit the funds in a timely manner.
Step 6: Calculate state and local taxes
Depending on where your business is located, state and local taxes may also need to be calculated. Don’t forget to send in those local taxes to the appropriate agency.
Step 7: Deposit federal, state and local taxes on time
Tax deposit schedules vary by state, with many requiring a quarterly deposit, so check with your local agencies to determine what your schedule will be. For the federal government, there are currently two deposit schedules; monthly and semi-weekly. Business owners will be notified at the beginning of the year what deposit schedule they need to use.
Whether you process payroll in-house or use a top-notch payroll service provider, it is up to you to ensure that taxes are calculated properly and paid on or before their due date. Businesses that fail to make timely deposits may be subject to a 15 percent penalty plus the interest charged on any outstanding taxes due.
While it may seem overwhelming, withholding and paying taxes is a fairly straightforward process. For more answers, check out our complete guide to processing payroll, or take a look at the IRS website to review their Employer’s Tax Guide.
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Erin Ellison is the former Content Marketing Manager for OnPay. She has more than 15 years of writing experience, is a former small business owner, and has managed payroll, scheduling, and HR for more than 75 employees. She lives and works in Atlanta.