How to Calculate Payroll: A Guide for Beginners

The importance of how you handle employee paychecks goes beyond the amount you pay them. Frequency of payment, accuracy of compensation, and thorough deductions are critical for managing employee satisfaction and ensuring your business complies with local, state, and federal laws.

This guide will walk you through all the necessary steps to calculate payroll accurately and effectively for your employees, including categorizing them, applying necessary deductions, and determining pay periods and timing. We’ll also detail how effective payroll software can simplify the process for business owners while guaranteeing accuracy.

What is payroll?

Payroll is the process of a business paying employees for their work via direct deposit or check. This includes the time tracking of all your employees, calculating their pay while taking into account any deductions and withholdings, and distributing payments in a timely manner.  

Why calculating payroll accurately is crucial

The Fair Labor Standards Act (FLSA) requires that employers pay employees accurately and in a timely manner for their hours worked or salaries, depending on an employee’s classification. These federal laws also require that employers — not employees — maintain accurate records for employee time and pay. 

This puts the responsibility entirely on you to ensure employee work is properly accounted for, though you are well within your rights to require employees to follow methods that make this easier.

There’s also the employee impact to consider. Being accurately compensated for their hours worked in a timely manner is a huge motivating factor for employees, and experiencing the opposite (wages unaccounted for, delays in payment) could impact employee morale in a way that causes your company’s profitability to suffer. 

How to calculate payroll manually

Here’s a step-by-step guide on how to complete the payroll process using strictly manual methods.

Step 1: Determine the classification of your workers

The first step in calculating payroll manually is determining how wages are meant to accumulate for your employees. This is determined by the classification of your workers, which comes down to two distinct categories.

Hourly workers

Hourly workers are employees that are paid on a per-hour basis. For example, if you manage construction sites and have a construction worker, Jake, getting paid an hourly rate of $20. In this scenario, Jake would only be paid when he works. 

Additionally, if he exceeds 8 hours in a workday or 40 hours in a workweek, he would be entitled to overtime pay for those hours in excess. Under the FLSA, overtime pay is at minimum a premium rate of pay equivalent to one and a half times his regular rate of pay. So, for any overtime hours he worked, Jake would be entitled to ($20 x 1.5) = $30 per hour.

Salaried workers

Salaried workers receive a fixed amount of pay each pay period, rather than a fluctuating amount depending on hours worked. Their steady rate of pay makes it easier to calculate their pay rates, as does the fact that they very rarely qualify for overtime. 

That said, whether or not they’re entitled to overtime will depend on your state and local laws, so make sure to check them to see if you’re in compliance. 

An example of a salaried employee is an office worker, named Bianca, getting paid a yearly salary of $35,000.

Hourly employees are almost always nonexempt from the FLSA rules on minimum wage and overtime laws, meaning a business owner must take into account those rules when compensating them. Meanwhile, salaried workers are often exempt from these FLSA rules, but not always exempt from them. 

Step 2: Determine the pay period

A pay period is the length of time in which employees are due to be compensated for their work. For example, a week (known as a weekly pay period) or every two weeks (known as a biweekly pay period).

The U.S. Bureau of Labor Statistics states that biweekly (aka semi-monthly) is the most common payroll schedule used in the United States. Therefore, we’ll choose this pay period — two weeks, or 10 business days — in our examples.

Step 3: Calculate an employee’s gross pay for the selected pay period

Let’s use the example of the two employees listed above — Jake, the hourly construction worker, and Bianca, the salaried office employee — to determine what their biweekly paycheck after two weeks of work would be. 

The first part of this is getting an accurate sense of how much time each employee worked. For the sake of this example, we’ll say you already have an accurate time-tracking system in place. 

Because of it, you know that Jake worked exactly 83 hours over the past two weeks: 40 hours the first week, and then 43 hours the second week, with three of those hours being overtime hours due to him staying late to take down scaffolding and barricades on the construction site.

That means that his wages due at the end of two weeks would be:  

80 hours (regular hours worked) x 20 (his hourly wage) = $1,600 +

3 x (overtime rate = 20 x 1.5 = 30) = $90

Jake’s total biweekly gross pay = $1,690

For Bianca, we can say she worked 79 hours over the two-week period (she left early on the second Friday to pick her kid up from daycare). Either way, it doesn’t matter, because as a salaried employee, she’s paid a fixed rate.

What is her paycheck due at the end of a two-week period?

If her annual salary is $35,000, we would be able to get her weekly paycheck by dividing this number by 52, the same number of weeks in a year. Since we’re looking at her biweekly paycheck, we instead want to divide her yearly salary by 26.

Bianca’s total biweekly gross pay = $35,000 / 26 = $1,346.15

However, it’s important to note that these figures are just gross pay, which leads us to the next step for calculating payroll.

Step 4: Subtract payroll deductions

Payroll deductions are any amount of an employee’s total earnings that are withheld for the purpose of paying taxes, garnishments, or deductions, plus benefits such as health insurance or retirement contributions. Deductions come in two types: statutory deductions and voluntary deductions.

Statutory deductions are required by law to be paid by employees. They most commonly include:

• Federal Insurance Contributions Act (FICA tax) – which includes Medicare tax and Social Security tax
• Federal income tax
• State income tax, if applicable
• Local income tax, if applicable

There are some other deductions that may be applied on a per-employee basis, such as a wage garnishment deduction ordered by state law (which sometimes comes into play for child support).

Medicare tax: The Medicare tax requires that both employers and employees contribute an equal amount. The total tax is 2.9%, so employers pay half (1.45%) and employees pay the other half (1.45%). You have to withhold an additional 0.9% from employee wages if they earn more than $200,000.

Social Security tax: Both employers and employees are responsible for contributing to Social Security tax. The total tax amount is 12.4%, which is split so that employers pay half (6.2%) and employees pay the other half (6.2%). 

Federal income tax: Federal income tax withholding varies greatly on a case-by-case basis. The IRS provides a useful withholding table to help determine how much tax to withhold depending on the pay frequency for your employees and the amount they’ve earned. 

Other determinants include the version of the Form W-4 on file for the employee (pre-2020 or post-2020), whether an employee has multiple jobs, filing status, number of pay periods, pre-tax deductions, and other provided information.

These statutory deductions are in contrast with voluntary deductions, examples of which include health insurance, dental, retirement funds, union dues, parking services, and more. The amount that these deductions cost varies greatly, meaning you would adhere to whatever the agreed-upon amount is for each one. 

Special considerations for employers:

• Federal Unemployment Tax: Federal unemployment tax (FUTA) is only the responsibility of an employer to pay and is not subtracted from an employee’s paycheck. However, only the first $7000 an employee earns is subject to be taxed at a rate of 6%.
• Rounding: The IRS’s withholding guide, Publication 15-T, states that employers are allowed to use rounding to the nearest dollar specifically for any income tax withholding figures. However, if you choose to do so, you must do so consistently. 

Withheld tax amounts are meant to be rounded to the nearest whole dollar by dropping amounts under 50 cents and increasing amounts from 50 to 99 cents to the nearest dollar. Under this rule, $2.20 would become $2 while $2.53 would become $3. 

Payroll deductions at work

Let’s apply these deductions to both examples of employees listed above.

We’ve already calculated that Jake is due a biweekly paycheck of $1,690 as compensation for his 83 hours of work. Now we need to apply the necessary statutory and voluntary deductions to ensure we’re in compliance with federal and state laws. For the sake of these examples, we’ll say we’re working from Michigan. 

Statutory deductions (Jake)

Starting with a wage of $1,690 and subtracting:

• Social Security tax: 6.2% of employee compensation = $104.78
• Medicare tax: 1.45% for employees = $24.51
• Federal income tax (W-4 is post-2020, Jake is single and not working multiple jobs) of the adjusted wage amount as per post-2020 guidelines: $104.38 + [22% of the excess over $1,188] = $215 (rounded)
• State income tax: 2.7% for the first two years in Michigan = $45.63 

Total statutory deductions = $104.78 + $24.51 + $215 + $45.63 = $389.92 

Voluntary deductions (Jake)

• Health Insurance: $15,000 annually, 17% of which is covered by employees = $2,550 total for employees to pay annually, which results in $98.08 deducted from each biweekly paycheck.
• Union Dues: $50 per 2-week period

Total voluntary deductions: $148.08

Total deductions overall: $538

$1690 – 538 = $1152

This means that in Jake’s case, of his $1690 earned for working 83 hours over a two-week period, his net pay is $1,152.

Now let’s look at Bianca, with her set salary resulting in a biweekly paycheck of $1,346.15 before deductions.

Statutory deductions (Bianca)

Starting with a wage of $1,346.15 and subtracting:

• Social Security tax: 6.2% of employee compensation = $83.46
• Medicare tax: 1.45% for employees = $19.52
• Federal income tax (W-4 is post-2020, Bianca is married and filing jointly, and not working multiple jobs) of the adjusted wage amount as per post-2020 guidelines: $44.60 + [12% of the excess over 1,008] = $85 (rounded)
• State income tax: 2.7% for the first two years in Michigan = $36.35 

Total statutory deductions = $224.33

Voluntary deductions (Bianca)

• Health Insurance: $15,000 annually, 17% of which is covered by employees = $2550 total for employees to pay annually, which results in $98.08 deducted from each biweekly paycheck.

Total voluntary deductions: $98.08 

Total deductions overall: $322.41

This means that in Bianca’s case, her $1,346.15 minus deductions results in a take-home pay of $1,023.74.

Step 5: Double-check the math

Before you run with these numbers to pay your employees, it’s time to double-check your numbers to ensure accuracy. Carefully read through the numbers and calculations. Were any mistakes made? Did you round, and if so, did you round consistently in compliance with the FLSA? 

Some employers use paycheck calculators to help handle the numbers, but trusting these to automate the process could result in some skewed figures you don’t notice until you check manually. 

Once you’ve verified that the figures are accurate, you can finally move on to actually paying your team members for their work.

Other options for calculating payroll

There are a couple of reasons why the process of doing payroll manually causes frustration for business owners. For one, it’s very involved and can change from year to year depending on new laws. Second, there is never a moment when you can afford to be on autopilot. 

Each employee has their own circumstances that have to be accounted for when handling taxes and withholdings to ensure pay is accurate.

And speaking of accuracy, each calculation is a chance for human error to skew numbers. Typing eight instead of nine or copying a number from the wrong section — these are all very normal ways to make a costly mistake over the hundreds of times you’ll be running payroll. 

This can even occur on the employee side before it’s even in your hands. What if the employee hours you’re working so tirelessly to calculate wages for aren’t even accurate?

These are just a few of the reasons that savvy employers upgrade from manual methods to other options to streamline the payroll process while increasing accuracy. These options include:

Combined time-tracking and payroll software

The number-one option for business owners and HR administrators looking to simplify the payroll calculation process is to use combined time-tracking and payroll software. These tools come with automatic features that ensure accuracy when it comes to employee hours. 

In addition to tracking time accurately down to the second, the versions of these tools that come with built-in payroll software make it easy to transfer over that data and automatically calculate payroll tax filings.

If you want a strong example of this, look no further than our very own Buddy Punch. With Buddy Punch, employees can clock in and out using their computers, a time clock kiosk, or their mobile phones. All hours are collected into timesheets, overtime hours are identified automatically, and total hours are calculated for you.

When it’s time to run payroll, you simply click a button, and Buddy Punch does the rest. Deductions are automatically calculated, and payments are made to all employees, tax organizations, and other organizations. Employees can be paid by check or direct deposit.

Standalone payroll software

Some business owners are particularly attached to their time-tracking methods, whether they use manual paper timesheets, physical time card readers, or some other digital time clock. These people may choose to use standalone payroll systems, such as QuickBooks Payroll or ADP, to handle their payroll. 

These tools come with many automatic features to help streamline the process, such as automatic payroll tax calculations, federal, state, and local compliance support, and sometimes expert support for troubleshooting and answering questions.

Payroll outsourcing

One last method to handle calculating your payroll is to opt out of having to handle it at all. There are many third-party payroll services that employ tax professionals to help ensure all your payroll needs are met. 

The level of comfort and reliability of having another person working on your taxes can beat the convenience of running it yourself, even with the help of reliable software. This is especially true if you use a local payroll business with intimate knowledge of any state and local laws that may be applicable to your company.

Whatever method of handling payroll you choose, you’ll want it to be something you can stick with for the foreseeable future as your business changes and grows. Thus comes the need to pick something reliable, affordable, and scalable. 

Common mistakes to avoid when calculating payroll

Here are a few mistakes you want to make sure you’re avoiding, regardless of how you’re going about handling payroll calculations.

Misclassifying employees

This is especially an issue for small business owners, where employees often take on multiple roles which can muddy how they’re meant to be classified. 

Understanding whether your employees are exempt or non-exempt has a huge impact on how payments are meant to be handled for them, so make sure you review the FLSA guidelines on this.

Miscalculating employee wages and hours

Human error is a natural occurrence during the payroll calculation process that can easily throw off calculations of employee hours or wages. You also have to worry about intentional falsification of time cards, which falls under time theft. 

Examples of time theft include buddy punching, exaggerating break times, or lying about clock-in or out times. A digital time clock with anti-time theft features comes in handy for preventing time theft.  

Omitting deductions

Another common mistake is leaving out deductions that are critical for compliance. Many business owners are well aware of federal tax rates but may forget to consider local taxes or pre-tax and post-tax deductions. 

It can take a decent amount of research to ensure you’re treating an employee’s taxable income with the proper consideration required by law.

Missing deadlines

It is your responsibility to keep up with any tax and payroll deadlines to ensure that payments are always handled in a timely manner, pay period after pay period. This can require you to be aware of any state, local, and federal deadlines, in addition to ensuring employees are paid on time. 

Any option you have to ensure you’re making deadlines, such as using automatic payroll processing, helps avoid this issue.

The bottom line

Calculating payroll is perfectly possible for a business owner to handle manually on their own. The only issue is that doing so opens you up to many opportunities for human error and entry manipulation, as well as eating into your time. 

This is why many business owners choose to use software or outsourcing to handle their payroll. What’s most important is choosing a method that will produce the least errors and streamline the process in a manner you can rely on long-term.