How to calculate payroll tax deductions for each employee

Hiring your first employee is a milestone worth celebrating, but it also comes with a learning curve. New employers might find themselves asking, “How do I calculate taxes from payroll?” only to discover that the salary they agreed on in the offer letter isn't the number that leaves their account. That gap is payroll taxes at work.

Between what you withhold, what you match, and what you owe on top, finalizing every paycheck requires a handful of separate calculations. Payroll software can handle most of it — but understanding how to calculate payroll taxes yourself will help you catch errors before your employees do, forecast the real cost of a hire, and stay compliant as you grow.

In this how-to guide, we cover the ins and outs of payroll tax deductions to help you understand how to calculate payroll taxes, what payroll taxes to pay employees, what the payroll tax rate is, and more.

Payroll taxes are the wage-related taxes that you’ll either pay as an employer or withhold from an employee’s paycheck and remit to the government on their behalf, including:

• Employee payroll taxes: These are the taxes you’re required to withhold from an employee’s wages. You’ll collect them on the government’s behalf, and then remit them.
• Employer payroll taxes: These are the taxes you must pay the government as a business, on top of paying wages to the employee.
• Payroll tax deductions: These are the specific tax amounts you’ll pull from each paycheck, including federal income tax, Social Security, Medicare, and any state or local taxes.
• Income tax withholding: This is the slice of federal (and often state) income tax you’ll hold back based on the employee’s Form W-4.

Simply put, gross pay is everything your employee earned this period, before anything comes out. Net pay is the amount that actually appears on their paycheck.

Pre-tax deductions, like health insurance premiums or eligible retirement contributions, come out before taxes are calculated. This lowers taxable wages, the base for calculating federal income tax withholding, Social Security, and the rest. Post-tax deductions come out afterward.

Example

Here’s an example of how one employee’s gross pay might compare to their take-home pay in a semi-monthly period.

The table above demonstrates what the difference between gross pay vs. net pay can look like, and the steps below share more details on how to calculate gross pay, taxable wages, and net pay for each employee.

Step 1: Calculate gross pay

The process for how to calculate gross pay will vary depending on whether the employee is salaried or hourly. Since bonuses and commissions count as gross pay, make sure to add them to the period’s wages before you calculate anything else.

For salaried employees

To calculate gross pay for your salaried employees, divide their annual salary by the number of pay periods.

For example, a $60,000 salary paid semi-monthly (24 periods) works out to $2,500 per period.

For hourly employees

To calculate gross pay for your hourly employees, multiply their hours worked by the hourly rate.

For example, someone who works 40 hours at $25 earns $1,000 for the week. Note: Overtime is paid at 1.5 times the regular rate for any hours worked that exceed 40 in a week, so an overtime hour here would be $37.50 instead of $25.

Step 2: Calculate taxable wages

Gross pay and taxable wages rarely match. To calculate taxable wages, subtract eligible pre-tax deductions from gross pay.

Common pre-tax deductions include health insurance premiums, HSA and FSA contributions, and traditional 401(k) contributions. One nuance: A 401(k) contribution lowers wages for federal income tax, but not for Social Security and Medicare. So, taxable wages can differ slightly between the two.

For example, say the salaried employee from Step 1 pays a $200 pre-tax health premium. That would bring their gross pay of $2,500 down to $2,300 in taxable wages, which becomes the base for deductions in Step 3.

Step 3: Calculate employee payroll tax deductions

There are some tax withholdings that you’ll need to withhold and/or remit on your employees’ behalf. Here’s how to calculate each tax.

Federal income tax withholding

To calculate federal income tax withholding, you’ll use the employee’s Form W-4, together with the current year’s IRS Publication 15-T tables. You’ll need to factor in filing status, pay frequency, dependents, and any extra withholding claimed by the employee.

Social Security and Medicare taxes

The Federal Insurance Contributions Act (FICA) funds Social Security and Medicare, and this federal tax is one that you and your employees will split evenly: You’ll each pay 6.2% for Social Security (up to the $184,500 wage base for 2026), and 1.45% each for Medicare (with no cap).

Once an employee's wages pass that wage base, you’ll stop withholding Social Security for the rest of the year — but you’ll still need to pay Medicare tax. (Note: The wage base changes most years, so confirm it each January.)

There's no wage base limit on Medicare, but once an employee earns more than $200,000 in a year, you’ll withhold an Additional Medicare Tax of 0.9% on wages above that threshold. This is an employee-only charge that you don't match as the employer.

To recap, here’s how to calculate these payroll tax deductions for each employee:

• Social Security: To calculate Social Security tax, multiply each employee’s taxable wages by 6.2%. (If the employee's wages exceed the wage base, you’ll stop withholding and remitting this tax for the year.)
• Medicare: To calculate Medicare tax, multiply each employee’s taxable wages by 1.45%. (If the employee's wages exceed $200,000, you’ll withhold an additional 0.9% in Additional Medicare Tax.)

State and local taxes

Many states have income tax withholding and some cities also add local taxes, though a handful of states have none. Research your state and local rules and apply them to the employee’s taxable wages.

Step 4: Calculate employer payroll taxes

Your employees aren’t the only ones paying payroll taxes. As noted above, you’re responsible for employer payroll taxes on every paycheck. Here’s how to calculate those taxes at the federal level.

Match Social Security and Medicare taxes

As noted in Step 3, employers and employees pay matching amounts for Social Security (6.2%) and Medicare (1.45%). So, for your employer payroll taxes, the amount you’ll owe as an employer is the same amount as the employee payroll tax deduction.

Calculate federal unemployment taxes

For the Federal Unemployment Tax Act (FUTA), you’ll need to pay 6% on the first $7,000 of each employee's annual wages, but a credit of up to 5.4% for paying state unemployment brings the effective rate to 0.6%.

Calculate state unemployment taxes

In most states, taxes for the State Unemployment Tax Act (SUTA) are only paid by the employer. Each state assigns the rate and wage base.

The IRS lets you withhold on supplemental wages (like bonuses) in two ways:

• Based on percentage: The percentage method of bonus tax withholding applies a flat 22% to the bonus (or 37% on amounts over $1 million in a year).
• Based on aggregate: The aggregate method lumps the bonus in with regular wages and withholds based on the W-4 tables.

Either way, bonuses are still subject to Social Security and Medicare taxes. That’s why a bonus check often looks smaller than employees might have expected. The flat supplemental rate is frequently higher than someone’s usual income tax withholding, and FICA still comes out on top.

A few errors tend to show up again and again, especially when you’re first figuring out how to calculate paycheck deductions. These include:

• Calculating taxes on gross pay (instead of on taxable wages), which overstates withholding
• Forgetting the employer payroll taxes and under-budgeting the true cost of payroll
• Miscalculating overtime by applying the regular rate after 40 hours
• Applying pre-tax deductions incorrectly, or to the wrong taxes
• Missing payroll tax deposit deadlines, which come with penalties
• Using outdated tax rates or wage bases
• Misclassifying a worker as a contractor, when they’re actually an employee

Manually tabulating one employee’s payroll tax deductions might feel fairly manageable. But doing the same for a growing team — especially when you’re managing different benefit elections and changing rates every pay period — is another story.

That’s when automating payroll can save the day. Payroll software can run the calculations, update withholding tables and wage bases as they change, handle direct deposit, and flag compliance issues early. This means many common payroll errors disappear, and all you’ll need to do is review and approve.

Calculating payroll taxes takes precision, current tax figures, and steady follow-through. By understanding the math behind each paycheck, you’ll have an easier time budgeting, forecasting, and spotting errors, even once you automate the work.

With Mercury's acquisition of Central, an AI-native payroll and benefits platform, you can run payroll from the same place you manage banking, cards, and bill pay — making payroll one more thing your business account can handle. Ready to reduce your payroll errors and your workload? Add Central to your Mercury stack today.

This article is for informational purposes only and does not constitute legal, tax, investment, or financial advice. Founders should consult their own legal and financial advisors before making important financial decisions.