How To Calculate Payroll: A Step-by-Step Guide for Small Business Owners

If you’re a small business owner grappling with the complexities of calculating payroll, you’re not alone. With a myriad of tasks to handle, from paying employees to all the work you put in to grow your business, dealing with payroll calculations and the IRS tax code may feel overwhelming and time-consuming.

Word of relief is that, although these responsibilities appear daunting, once you understand the necessary tax filings and learn the calculation process, it becomes more manageable. Getting started is commonly the worst part of many things, so to help you navigate this process, we’ve prepared a comprehensive step-by-step guide on how to calculate payroll and payroll taxes.

Here, you can find comprehensive answers to most, if not all of your payroll questions. And if you encounter any challenges or prefer to offload the responsibility of payroll taxes, our software for payroll can handle the heavy lifting for you. But don’t take our word for it. You can explore PrimePay’s client reviews to gain insights from businesses that have partnered with us.

Without further ado, let’s dive right in.

How to Calculate Payroll

In order to begin calculating payroll, you’ll need to have your employees complete the following new employee forms:

• Form W-4: Also known as Employee’s Withholding Certificate, this tax form is used by employees in the United States (U.S.) to determine their income tax withholding. In other words, this form is used to inform their employers about the amount of federal income tax to withhold from their paychecks.
• State W-4 (as applicable): Also known as the Employee’s Withholding Allowance Certificate for State Taxes, this tax form is used by employees in the U.S. to inform their employers about the amount of state income tax to withhold from their paychecks.
• Direct Deposit Authorization Form: If you’re planning to use direct deposit to pay your employees, this form allows individuals to authorize their employer or other payers to deposit their payments directly into their bank account.
  • Employers can require direct deposit in the following states:
    • Alabama
    • Indiana
    • Kansas
    • Kentucky
    • Louisiana
    • Maine
    • Massachusetts
    • Mississippi
    • Missouri
    • Nebraska
    • North Carolina
    • North Dakota
    • Ohio
    • Oklahoma
    • Oregon
    • South Carolina
    • South Dakota
    • Tennessee
    • Texas
    • Wisconsin
• Form I-9: Also known as Employment Eligibility Verification, Form I-9 is a document used in the U.S. to verify the identity and employment authorization of individuals hired for employment. The U.S. Citizenship and Immigration Services (USCIS) requires employers to complete Form I-9 for each employee hired, including citizens and noncitizens.

To stay compliant, it’s imperative that you get familiar with employment tax due dates associated with payroll-related forms and reporting. The bottom line is, staying on top of employment tax due dates is just as imperative as paying your employees on time. So study up on the requirements before you get started to dive right in with confidence.

Resources from the Internal Revenue Service (IRS):

• IRS Tax Calendar 2023
• Understanding Federal Tax Deposits

Now that we’ve got some of the startup forms covered, and your employees set up, you’re ready to run payroll and begin calculations (that is if your business is set up, too, of course).

Part of getting payroll set up is determining the total time employees worked for the period. But please note: this will be different for salaried employees vs. hourly employees.

Total Amount of Time Worked for Salaried Employees

For salaried employees, you’ll need to calculate their total amount of time worked based on their annual salary. Divide their annual salary by the number of pay periods in a year (usually 26 or 52), and then divide that number by the number of work hours in a pay period. This will give you the total amount of time worked for the pay period.

Related: PrimePay’s Salary Paycheck Calculator

Total Amount of Time Worked for Hourly Employees

For hourly employees, you’ll need to calculate their total amount of time worked based on their hours worked for the pay period. This can be done manually, or by using a tool like PrimePay’s Hourly Paycheck Calculator.

If you prefer to do things manually, here are the steps to effectively calculate the total amount of time worked for hourly employees:

• Gather Timekeeping Records: Collect all the timekeeping records for the pay period. This may include timesheets, time clock data, or any other method used to track employee hours.
• Review Work Hours: Thoroughly review the timekeeping records for each employee. Ensure that all hours are accurately recorded, taking into account regular working hours, overtime, breaks, and any other applicable time classifications.
• Calculate Regular Hours: Determine the regular hours worked by each employee. Regular hours typically refer to the standard working hours agreed upon in employment contracts or company policies.
• Identify Overtime Hours: Identify any hours worked by employees that exceed the predetermined threshold for overtime. This threshold is usually based on local labor laws or employment agreements.
• Calculate Overtime Hours: Calculate the total overtime hours for each employee. Overtime hours are typically compensated at a higher rate than regular hours, so accurate calculation is crucial for fair and compliant payroll.
• Account for Time Off: Take into consideration any approved time off, such as vacation days, sick leave, or holidays, and adjust the total hours worked accordingly. Ensure that the appropriate deductions or accruals are applied based on your company’s time-off policies.
• Verify Accuracy: Double-check all calculations to ensure accuracy. Mistakes in calculating hours worked can result in incorrect wages and potential compliance issues. A thorough review helps minimize errors and ensures employees are compensated fairly.