To calculate payroll, the company must first determine the total amount of wages the employee is eligible to receive. Various deductions must be subtracted from the total amount in order to pay for benefits or retirement plans, while other deductions must also be taken to pay national and local taxes as well as other government programs. Lastly, any other voluntary deductions are subtracted, and the remainder of the money is issued to the employee. While many larger companies prefer to hire a third-party to calculate payroll for them, most smaller businesses choose to calculate payroll in-house.
In order to accurately calculate payroll, the proper wages need to be determined. Many employees are paid on an hourly basis, receiving a set amount of money for every hour worked. For hourly employees, the number of reported hours worked each week would be multiplied by the hourly rate, with adjustments made for any overtime pay, if applicable. Other employees are paid on a salaried basis, receiving a fixed amount of pay per week, regardless of the hours worked.
Knowing how to properly calculate payroll is particularly important when it comes to determining both mandatory and voluntary deductions. Once the total wages have been determined—sometimes referred to as gross wages—, the deduction process begins. Many employee benefits are considered non-taxable and are, therefore, deducted before federal and state taxes are withheld. This may include items such as health insurance premiums, supplemental life insurance costs, or savings for a traditional 401K savings plan or other retirement program.
After the pre-tax deductions have been taken, the employer must then withhold the proper amounts from each employee's pay to cover various federal and state programs. Total income, marital status, and number of eligible dependents are all factors used to calculate payroll with regards to income tax withholding. A portion of the income taxes paid are often recouped at the end of the year when it comes time to file annual income taxes with the American Internal Revenue Service. Both Social Security and Medicare payments are also deducted and go towards funding the government-run programs. Income tax, on the other hand, may often be recouped in whole or part each year when taxes are filed.
The final deductions withheld from an employee's pay are voluntary and involuntary deductions which may not qualify under the pre-tax category. Voluntary deductions include additional contributions to a retirement savings plan or charitable deductions. Involuntary deductions are typically child support payments or alimony that is withheld directly from the employee's wages. Now that the employer has taken the proper steps to calculate payroll, the funds are dispersed to the employees in the form of a payroll check or as a direct deposit into one or more checking accounts.