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. 

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. 

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First, Calculate Gross Pay

Calculate Withholding and Deductions
Calculating Withholding and Deductions from Paychecks. Ian Jeffery/Getty Images

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.

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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.
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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.  More

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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.

 

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An Important Note About Gross Pay:

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.