When you consider the time and detail that's required to process payroll manually, you may better understand the efficiency that payroll software has brought to the modern workplace. Here's a look at some of the calculations and requirements that employment and tax laws and regulations play in determining how to calculate payroll, and just how complicated the process can become when completed manually.
The federal Fair Labor Standards Act (FLSA) establishes minimum wage, overtime pay, recordkeeping, and youth employment standards affecting employees in the private sector and in Federal, State, and local governments. Covered nonexempt workers are entitled to a minimum wage of not less than $7.25 per hour. Overtime pay at a rate not less than one and one-half times the employee’s regular rate of pay is required after 40 hours of work in a workweek. The FLSA requires that while an employee's workweek may begin and end on any given day (and at any hour), it must be based on a fixed and regularly recurring period of 168 hours, for seven consecutive 24-hour periods.
To calculate wages manually for an hourly employee who has not worked more than 40 hours in a workweek, multiply the employee's hourly rate by the number of hours worked in the pay period to calculate gross regular pay. For example, an employee who is paid $13/hour and works 40 hours has earned $520 in gross regular pay.
If the employee worked more than 40 hours in a single workweek and is classified as non-exempt, he or she is eligible for overtime. Without any additional remuneration such as commission or bonus payments, you can multiply the employee's hourly rate by 1.5, and then apply that rate to the overtime hours worked. If the employee in the example above worked a total of 48 hours in a workweek, for example, they may be eligible for 8 hours of overtime pay. The overtime pay is calculated based on:
$13/hour X 1.5 = $19.50 (overtime rate)
$19.50 X 8 hours = $156 gross overtime pay
To calculate a paycheck for salaried employees, you must first determine whether the employee is eligible for overtime. The FLSA provides an exemption from overtime pay for executive, administrative, professional, and outside sales employees. To qualify for an exemption, an employee must be paid on a salary basis, certain tests must be met regarding the employee’s job duties, and the employee must earn a threshold salary amount. While there are some exceptions, the threshold for exempting certain employees from overtime protections is currently $455 per week (or $23,600 per year). If the employee is considered eligible for overtime pay after applying the duties tests and/or looking at the employee’s salary level, you can calculate the overtime pay by first converting the salary to an hourly rate and multiplying that rate by 1.5 (again, assuming there is no other remuneration such as a commission or bonus).
If after analyzing the duties test you determine that the salaried employee is classified as exempt and not eligible for overtime pay, calculate their gross wages by dividing their annual salary by the total number of pay periods in a year. For example, an employee with a salary of $75,000 who is paid biweekly receives 26 paychecks a year (but may receive 27 in some years). Divide $75,000 by 26 to calculate their biweekly salary of $2,884.
Calculate Tax Withholding
Reference each employee's Form W-4 to calculate a paycheck that accurately reflects each individual's desired allowances/withholding amount for federal income taxes. Multiply the number of allowances the employee has claimed by the exemption amount for each allowance based on your company's pay schedule. For 2017, the IRS' Circular E, Employer’s Tax Guide states that the value of one withholding allowance for a person on a weekly pay schedule equals $77.90. If an unmarried employee earns $800 on a weekly pay schedule and claims two allowances, multiply $77.90 by two, to calculate a total withholding value of $155.80; subtract that amount from the weekly pay of $800.
The remaining number ($644.20) represents the amount subject to withholding. Refer to the IRS percentage method tables in the Employer’s Tax Guide for income tax withholding based on an employee's income, marital status, and pay schedule to determine how much tax to withhold from $644.20. In this specific example based on the IRS table, the employer would withhold $81.03 from each paycheck.
Calculate Social Security and Medicare Taxes
The Social Security Administration states that for the 2017 tax year, Social Security withholding equals 6.2 percent of all earnings up to $127,200; the Medicare percentage is 1.45 percent of all earnings. Individuals with earned income of more than $200,000 (or $250,000 for married couples filing jointly) must pay an additional 0.9 percent in Medicare tax. Reduce the employee's net pay by the tax withholding calculations.
Account for Contributions to Benefits
Your company may also provide employees with the option to contribute toward certain benefits. This can include one, some, or all of the following:
- Workplace-sponsored retirement plans
- Health, life, or disability coverage
- Flexible spending accounts
- Employee stock purchase plans
In such cases, you’ll need to calculate and deduct each employee's individual contributions from each paycheck.
Refer to State and Municipal Tax Laws
While some states have no income tax withholding, most do. State and municipal tax rates vary based on where each of your employees earn income. Consult the state-specific guidelines where you do business to confirm whether you need to withhold taxes from employees’ paychecks, and at what rate.
Whether you started your career long before payroll software was available or have yet to calculate a paycheck by hand, there's clearly a considerable amount of time and effort required to accurately process payroll. When you leverage the technologies now available to help simplify the payroll process, you can improve your own productivity, and greatly reduce what could be hours of each week spent issuing paychecks manually.
Note: This article is based on federal wage and hour law. State and/or local laws may vary, and may provide additional compensation and/or be more stringent than federal law.