How to Calculate Payroll Manually Step by Step

Manually calculating payroll involves precise steps to ensure accurate employee payments and tax obligations. This process demands meticulous attention to detail and a clear understanding of financial inputs and regulatory requirements for transparency and compliance.

Preparing Your Payroll Data

Before calculations begin, gathering all necessary employee and payroll-related information is foundational. Essential details include full legal name, current address, and Social Security Number for tax reporting.

A primary document for federal tax withholding is the IRS Form W-4, Employee’s Withholding Certificate. This form, completed by the employee, provides vital information such as filing status, dependents claimed, and any additional withholding amounts, directly influencing federal income tax withholding. Many states and local jurisdictions also have their own equivalent withholding forms.

Establishing the employee’s pay rate and schedule is another preliminary step. This encompasses hourly rates, fixed salaries, or commission structures, along with pay period frequency (weekly, bi-weekly, semi-monthly, or monthly). For hourly employees, accurate time records, like detailed timesheets, are indispensable for determining precise hours worked.

Collect documentation for all authorized deductions. This includes authorizations for pre-tax deductions (e.g., health insurance premiums, traditional 401(k) contributions) and post-tax deductions (e.g., wage garnishments, Roth 401(k) contributions).

Determining Gross Wages

The initial step in payroll calculation is determining an employee’s gross wages, their total earnings before deductions. For hourly employees, calculate gross wages by multiplying their regular hourly rate by the number of regular hours worked.

If an employee works more than 40 hours in a workweek, federal law generally requires overtime pay. This is calculated at a rate of at least one and a half times their regular hourly rate for those additional hours. Salaried employees typically receive a fixed amount of gross pay for each pay period, regardless of the exact hours worked. Their annual salary is simply divided by the number of pay periods in the year. Gross wages can also include other forms of compensation, such as bonuses, sales commissions, or other supplemental wages earned during the pay period.

Calculating Withholdings and Deductions

Once gross wages are determined, the next extensive phase involves calculating various mandatory and voluntary deductions. This process begins by accounting for pre-tax deductions, which reduce an employee’s taxable income. Common pre-tax deductions include qualified health insurance premiums and contributions to pre-tax retirement plans, such as traditional 401(k)s or 403(b)s, as well as certain flexible spending accounts. These amounts are subtracted from the gross wages to arrive at the taxable gross wages, the figure used for calculating most tax withholdings.

Federal Income Tax (FIT) withholding is determined using the information from the employee’s IRS Form W-4 and the computational instructions provided by the IRS in Publication 15-T, Federal Income Tax Withholding Methods. This publication details two primary methods: the wage bracket method and the percentage method. The wage bracket method uses tables that show the amount to withhold based on the employee’s filing status, pay period, and adjusted gross wage. The percentage method involves applying a specific percentage to wages that fall within certain income brackets. Employers must consult the most current version of Publication 15-T, which is updated annually, to ensure accurate withholding.

Federal Insurance Contributions Act (FICA) taxes are another mandatory withholding, funding Social Security and Medicare programs. For 2025, the employee’s share of Social Security tax is 6.2% of taxable wages, up to an annual wage base limit of $176,100. Once an employee’s cumulative gross wages for the year reach this limit, no further Social Security tax is withheld. The Medicare tax is 1.45% of all taxable wages, with no wage base limit. An additional Medicare tax of 0.9% applies to wages exceeding $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately.

State and local income taxes vary significantly by jurisdiction. Employers must consult specific state revenue department websites or local tax authorities for their unique withholding tables and forms. Employees complete state-specific forms to determine state income tax withholding based on their individual circumstances. These resources guide the calculation of the correct state and local tax amounts to be withheld from an employee’s pay.

After all mandatory taxes have been calculated and accounted for, any post-tax deductions are then subtracted. These deductions are taken from the employee’s pay after all pre-tax deductions and tax withholdings have occurred. Examples of post-tax deductions include wage garnishments mandated by court orders, contributions to Roth 401(k) plans, or union dues.

Finalizing Net Pay and Record Keeping

The final step in the manual payroll calculation process is determining the employee’s net pay, which is the amount they actually receive. This figure is derived by taking the gross wages, subtracting all pre-tax deductions, then subtracting all calculated tax withholdings, and finally subtracting any post-tax deductions. The formula can be summarized as: Gross Wages – Pre-Tax Deductions – Taxes – Post-Tax Deductions = Net Pay.

Following the calculation, creating a detailed pay stub for each employee is important for transparency and compliance. A pay stub should clearly itemize all components of the employee’s compensation. This includes the gross pay, a breakdown of each pre-tax deduction, every tax withheld (federal, state, and local), and all post-tax deductions. Additionally, the pay period dates and year-to-date totals for all categories, such as gross pay, taxes, and deductions, should be clearly displayed on the pay stub.

Maintaining meticulous records of all payroll activities is a strict requirement for businesses. Key documents to retain include copies of IRS Forms W-4, state withholding forms, employee time sheets, and comprehensive payroll registers detailing all calculations. Copies of issued pay stubs, deduction authorizations, and records of all tax payments made to federal and state agencies must also be kept.

The Internal Revenue Service (IRS) generally requires that employment tax records, including Forms 941, W-2s, and W-4s, be retained for at least four years after the date the tax was due or paid, whichever is later. Some specific records, such as those related to retirement plan contributions, may need to be kept for longer periods, potentially up to six years under the Employee Retirement Income Security Act (ERISA).