How Taxes are Calculated

Depending on the nature of the tax, each tax is calculated in one of several different ways. Let’s take a look at the taxes most commonly encountered in the payroll world.

FICA – Employee and Employer Tax

FICA is composed of two taxes: Social Security and Medicare.

Social Security

Social Security is calculated by multiplying an employee’s taxable compensation x 4.2%. For example, if an employee’s taxable compensation is $500 this week:

$500.00 x 4.2% = $21.00 (this amount would be deducted from the pay check)

There is a wage base limit for Social Security. For 2012, this tax is calculated only on the first $110,100 earned.

As mentioned in the previous Payroll 101 entry, the employer also pays this tax. They pay it at the rate of 6.2% and are subject to the same wage base limit ($110,100 for 2012).

The total amount sent to the IRS for Social Security tax in 2012 will be 10.4% of taxable compensation (4.2% is the employee share, and 6.2% is the employer share, for a total of 10.4%). A specific formula is used when calculating the employer share of Social Security.

$500.00 x 10.4% = $52.00 (the total amount due for SS tax)

Medicare

Medicare is calculated by multiplying an employee’s taxable compensation x 1.45%. For example, if an employee’s taxable compensation is $500 this week:

$500.00 x 1.45% = $7.25 (this amount would be deducted from the paycheck)

There is no wage base limit for Medicare.

This is a tax that also requires an employer contribution. Employers pay it at the same rate as the employee (1.45%). If the Medicare tax for the employee portion of the tax is $7.25, the employer’s Medicare tax amount is also $7.25.

The total amount sent to the IRS for Medicare tax is 2.9% of taxable compensation (1.45% employee share plus 1.45% employer share is a total of 2.9%). A specific formula is used when calculating the employer share of Medicare.

$500.00 x 2.9% = $14.50 (the total amount of Medicate tax to be paid)

Federal Income Tax – Employee Only Tax

This tax (also known as Federal Withholding Tax, FWT, or FIT) is calculated using an IRS formula which considers an employee’s marital status, number of exemptions, pay frequency, and taxable compensation. There are several IRS-approved methods of calculating this tax; we will use the Percentage Method in this program.

FUTA (federal unemployment tax) – Employer Only Tax

Federal unemployment taxes are paid by the employer only. The Federal Unemployment Tax Act (FUTA) rate is currently set at 6.0%. Employers who pay their state unemployment tax on time receive an offset federal unemployment tax credit of 5.4% resulting in a net FUTA rate of 0.6%.

FUTA tax is calculated by multiplying an employee’s taxable compensation x .6%. For example, if the employee’s taxable compensation is $500 this week, the employer would pay:

$500 x .6% = $3.00

There is a wage base limit for FUTA. For 2012, this tax is calculated only on the first $7,000 earned. The wage base limit has not been changed since 1983.

State Income Tax – Employee Only Tax

This tax (also known as State Withholding Tax, SWT, SIT, or PIT) is typically calculated based on the same parameters as federal income tax. However, there are some states that may calculate income tax as a flat percentage of taxable compensation. There are nine states that do not have a provision for state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

Other State Taxes – Employee and/or Employer Taxes

Other state taxes that employees may be subject to are disability insurance, state unemployment, and local taxes. These taxes may also require an employer contribution.

Below is a chart which describes each tax. Please note: state taxes may be employer, employee, or both. Calculations vary from state to state.

Tax Type	How It’s Calculated / Limits	Employee	Employer
Federal Income Tax	Marital Status, # of Exemptions, Pay Frequency, Taxable Compensation	X
Social Security Tax	Employee: 4.2% of Taxable Compensation Wage Base Limit ($110,100)	X
	Employer: 6.2% of Taxable Compensation Wage Base Limit ($110,100)		X
Medicare Tax	1.45% of Taxable Compensation	X	X
FUTA	.6% of Taxable Compensation Wage Base Limit ($7,000)		X
State Income Tax	Varies by State	X
State Disability Ins	% of Taxable Compensation (% varies by state) Wage Base Limit Varies by State	X	X
State Unemployment	% of Taxable Compensation Wage Base Limit Varies by State (wage base limit cannot be less than $7,000)	X	X
Local Taxes	% of Taxable Compensation (% varies by locality) Wage Base Limit Varies by State	X	X

The material contained in this document is for informational purposes only and is current as of the date of publication. CompuPay is not a legal advisor or financial advisor and makes no claims as such. For financial or legal advice, please seek the advice of a professional.