September 26, 2023

How to Calculate the Amount of Wage Withheld from an Employee’s Paycheck

If you run a small business, you’ll soon face the dilemma of whether you should hire employees or contractors.

Among the many differences between the two, you’ll have to pay taxes on an employee’s behalf. But how much are you supposed to take out from their wages?

This detailed guide will show you the basics of wage withholding. This will help you decide if you’re ready to add employees to your team.

Here’s what you need to know:

Get Your W-4 Forms

The first step is to collect W-4 forms from all your employees. This is a form that they’ll have to fill out and sign.

It’ll display their name, address, and social security number. You’ll need this information to confirm their employment with your company. You’ll use this information to send a W-2 form after the tax year ends.

Once you have this information, you’ve confirmed their employment. Now let’s look at how to withhold wages.

What’s the Gross Pay?

There are multiple ways to calculate gross pay. First, let’s look at the rule for salaried employees.

You take the annual salary and divide it by the number of pay periods. Let’s say you pay your employee $100,000 and get paid once per week.

$100,000 divided by 52 weeks is approximately $1923 per week. This is their gross pay.

For an employee who works on an hourly rate, you calculate their hourly rate by how often they work each pay period. If they earn $20 per hour for 40 hours per week, then their gross pay is $800.

Now that you’ve got the gross pay, you’ve got to withhold wages for different types of taxes. Let’s start with social security taxes.

Wage Withholding for Social Security

You’ll have to withdraw 7.5% of your employee’s gross wages to pay for their social security. As an employer, you aren’t paying the full amount to them.

Rather, you are paying 50% of their social security tax. This is the first tax you’ll have to calculate. Make sure you set aside this money first before you withdraw any other type of tax.

Federal Income Tax

This is a much harder task and you might need the help of a tax accountant. The federal income tax rates always change so you must keep abreast of these changes.

Federal income tax also depends on whether your employee is single or married. As the US has a progressive tax system, the tax rates increase with higher salaries.

If your state also has an income tax rate, you’ll have to calculate this as well. However, make sure you always deduct the federal income tax first.

Medicare Tax

The final tax withdrawal is for Medicare. This is a flat rate of 1.45% and has a maximum limit of $200,000.

This is the final amount you’ll withdraw from the paycheck. Anything left will go to the employee as their paycheck.

Calculation Example

Let’s now look at a full calculation. Let’s return to the first example where one’s gross pay is $1923.

$1923 has to have a 7.5% deduction for social security. This is approximately $144.

So now we subtract $144 from $1923. This leaves you with a total of $1779.

Now, you withdraw the federal income tax. For 2022, the tax rate for an annual salary of $100,000 but less than $182,100 is 24%.

So now, we calculate 24% from $1779. It is approximately $427. This comes to a total of $1,352.

If you have a state income tax, you have to subtract it now. But let’s assume that your employees live in a state without income tax. The remaining tax is 1.45% for Medicare.

1.45% of $1,352 is approximately $20. So now the total is $1,332. This $1,332 is how much you’ll pay your employee each pay period.

Now let’s look at some of the other financial obligations you’ll have toward your employees and your company.

Payroll Tax

Payroll tax is one of the most important taxes you’ll have to pay for your business. Failure to do so can lead to your business being shut down.

As a result, you’ll have to first set aside payroll tax before you can pay your employee’s wages. There are times when you might go into debt and have to enroll in payment plans.

You can look at these back payroll tax resolution details on how to deal with back taxes.

Ask your accountant how you’ll set aside payroll taxes. Once you calculate your cash holdings after your payroll taxes, then you’ll have to check if you have enough cash to pay your employees.

Best Practices

Now you have to decide if you want to hire an employee or stick to a contractor. The advantage of the latter is that you’ll only have to pay them wages.

You won’t have to engage in wage withholding when it comes to contractors. However, the major detractor for hiring contractors is that you won’t have as much flexibility in managing them. They have more freedom in their role than you do.

As a result, it’ll benefit your business in the long run to hire employees. You might want to start by hiring a part-time employee. Test out if you can afford to pay them and pay your taxes.

At first, you’ll want to pay the minimum wage in your area. This lets you build a steady cash flow. Once you have a stronger cash flow then you’ll be able to add more employees to your team.

If you miss tax payments, there are serious consequences for both the IRS and your employees. Make sure you work to build your company’s cash reserves before hiring employees.

Find Your Employees

Now you know how wage withholding works and how to ensure you can pay the taxes.

You’ll have to first calculate the gross pay for your employees. Afterward, you’ll have to calculate the different tax rates. Tax rates can change with every political administration, so keep updated about the changes.

Once you remove all the taxes from the gross pay, then the difference is what you pay your employees. Make sure you estimate how much tax you’ll owe before you hire an employee.

You can find more business and finance-related articles on our website.

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