How to Calculate Deductions from Employee Paychecks

Federal Income Tax, FICA Tax, and More

In this article you will find detailed explanations of how to calculate all withholding and deductions from employee paychecks. It's easier than you might think. 

Your goal in this process is to get from the gross pay amount (gross pay is the actual amount you owe the employee) to net pay (the amount of the employee's paycheck.

After you have calculated gross pay for the pay period, you must then deduct or withhold amounts for federal income tax withholding, FICA (Social Security/Medicare) tax, state and local income tax, and other deductions.

What's the difference between deductions and withholding?

Not much, really, except that withholdings are typically for federal or state taxes, like income tax and FICA taxes. Deductions are for other amounts which can be taken from an employee's paycheck, like retirement benefits, health care costs, or special funds and donations. 

Use Gross Pay for All Calculations

When you calculate withholding and deductions, you must use the employee's gross pay amount for each calculation. The calculations are not progressive, with lesser and lesser amounts being used for the calculations. 

1
First, Calculate Gross Pay

Employee paychecks start out as gross pay. Gross pay is the total amount of pay. For salaried employees, it's an annual amount divided by the number of pay periods. For hourly employees, it's the number of hours worked times the rate (including overtime.

If you are not sure what kind of employees you have, read this article on the difference between salaried and hourly employees. 

Overtime is tricky. All hourly employees are entitled to overtime if they work over 40 hours in a week. Some salaried employees are exempt from overtime, depending on their pay level. Lower-paid salaried employees must receive overtime. 

These articles on overtime might help you sort out the overtime pay issue: 

Hourly employees and overtime

Exempt vs. non-exempt employees: Overtime rules

  More

2
Second, Calculate Federal Income Tax (FIT) Withholding Amount

Then calculate an employee's federal income tax withholding.

To find the amount to be withheld from an employee paycheck for federal income tax, you must start with the employee's Form W-4 - Employee's Withholding Allowance Certificate.

Form W-4 is completed by the employee. It shows the employee's

  • Marital statu
  • Number of allowances (usually related to the number of family members or dependents, but not always), and
  • Additional deduction amounts.

Use the W-4 information and the tax tables from the IRS in Publication 15: Employer's Tax Guide) to determine the withholding amount for the pay period. This amount may change from payroll to payroll.  More

3
Third, Calculate Social Security and Medicare Deductions

You must deduct FICA taxes (Social Security and Medicare) from employee paychecks.  The calculation for these deductions is pretty straightforward. The amount of FICA tax is 15.3% of the employee's gross pay. 

Half of the total (7.65%) is withheld from the employee's paycheck, and half is paid by the employer. 

Be careful not to deduct too much Social Security tax from high-income employees, since Social Security is capped each year, with the maximum amount being set by the Social  Security Administration. 

You will also need to consider the additional Medicare tax deduction on higher-income employees, which begins when the employee reaches a specific pay amount for the year. The additional tax is 0.9% of the gross pay, and it starts at different levels, based on the employee's W-4 status. No additional tax is due from the employer.  More

4
Fourth, Determine State Income Tax Deductions

Most states impose income taxes on employee salaries and wages.  You will have to do some research to determine the amounts of these deductions and how to send them to the appropriate state/local taxing authority.  Your responsibilities as an employer for deducting, paying, and reporting these taxes are discussed in this article.

 

Back to All About Payroll Taxes More

5
Other Deductions

 You're not quite done yet with deductions. Here are some other possible deductions from employee pay you might need to calculate: 

  • Deductions for employee contributions to health plan coverage
  • Deductions for 401(k) or other retirement plan contributions
  • Deductions for contributions to internal company funds or charitable donations. 

Remember, all deductions are based on gross pay.