What is Payroll Expense and How to Calculate it 101
January 09, 2023
Calculating payroll expenses is essential if you want to make your accounting a breeze, but not many people are familiar with it when they are starting their business.
If you don’t know what payroll expenses are, you can read this article and get all the answers you need! We will define them and explain what you need to take into account to calculate them and how to do it properly.
Let’s get straight to it!
What is Payroll Expense?
Payroll expense is the amount of money employers pay to cover the costs of salaries and wages for their employees and independent contractors. It includes the costs related to payroll taxes, benefits, and employees’ salaries.
The simplest way to understand payroll expenses is to look at them as rewards for the employees’ qualifications and work complexity, quality, and quantity. Based on the worker’s employment type, payroll costs could also include bonuses, tips, paid leave, and commissions.
Typically, payroll expenses are the largest expense that a company might have. This is especially true for businesses whose revenue is related to staff hours worked. Yet, in an asset-intensive business—such as an oil refinery, for example—payroll expenses aren't as big.
What is Calculated Toward Payroll Expense?
Let’s take a look at the types of costs that are calculated toward payroll expenses.
#1. Gross Wages
Gross wage, or pay, is the amount of money your workers earn before benefits, taxes, and other deductions are withheld from their wages. To calculate it, you should multiply the total number of working hours by the employee’s hourly wage.
Keep in mind that any overtime your employees might have earned also goes toward calculating their gross wages.
If you’re working with salaried workers, then you’ll also have to cover the cost of their salaries. A salary is a fixed income your employees earn for every pay period, regardless of how many hours they have worked or how much work they have completed.
Next, as an employer, you are also required to pay deductions for state and federal income tax withholdings. The amount you have to pay is usually specified on your employee’s W-4 form.
You also have to take into account the FICA taxes, which include Medicare and Social Security taxes. As of the date of this article, employers are obliged to pay a 1.45% Medicare tax and a 6.2% Social Security tax, which equals 7.65% in total.
#4. Employee Benefits
If you offer benefits to your employees, you may withhold a portion of these costs from their pay. These amounts include the employee’s share of insurance premiums or retirement contributions. Some other costs that you’ll need to factor in if you offer benefits are:
- Paid leave (sick days and vacations)
- 401(k), pension plans, and savings plans
- Post-retirement health insurance
How to Calculate Payroll Expenses
Now that you know what counts toward your payroll expenses, it’s time to learn how to calculate them. Read on and find out in the section below!
#1. Collect Information from W-4 Form
Every employee that you hire must complete the W-4 form, which tells you how much you should withhold from their pay stub for tax. To determine tax withholdings, you must collect information such as the number of allowances or the gross pay.
Employees can download the W-4 form from the official IRS website.
#2. Calculate Net Pay by Using Gross Pay and Deductions
Net pay is the amount your employee receives after all withholdings and deductions. To calculate it, you need to deduct FICA taxes, insurance, benefits, and income taxes from their gross pay.
For example, if your employee’s gross wage is $60,000, you need to deduct 5% for state income taxes, 20% for federal income taxes, 7.65% for FICA taxes, and $50 for health insurance. This would mean that your employee’s net pay would be $1,909 for each pay period.
#3. Submit Payroll Tax Deposits
As a business owner in the U.S., you must submit deposits for tax withholdings. These include the following:
- Federal income taxes
- State income taxes
- FICA taxes
- FUTA taxes
#4. Fill out Payroll Tax Forms
Completing payroll tax forms might be the hardest part of paying payroll expenses, as you’ll have to fill out a bunch of paperwork and submit it on time. The forms you have to fill out are:
- Form 941, which is used to report federal income taxes and FICA taxes each quarter.
- Form 940, which you can use to report your annual federal unemployment tax return (FUTA).
- Form 1096, which ismainly used for annual reporting of the money you paid to your independent contractors.
- Form W-3, which you should file with the Social Security Administration every year. It reports the total wages and tax withholdings for your employees.
#5. Collect and Save Your Records
According to the Fair Labor Standards Act (FLSA), every business owner in the U.S. is required to keep employee records for at least two years. That’s why you should always collect all of the forms you file after managing your payroll expenses and keep them stored away safely.
- Payroll expense is the amount of money you pay to cover the costs of salaries, insurance, taxes, and withholdings for your employees.
- In most cases, payroll expense is the largest expense that a company might have.
- The factors that are calculated toward payroll expense include gross wages, salaries, taxes, and employee benefits.
- To calculate payroll expenses, you need to collect information from Form W-4, calculate net pay, fill out payroll tax forms, and submit payroll tax deposits.
- You are required by law to keep all employee records for at least two years after managing your payroll expenses.
Processing payroll expenses isn’t an easy thing to do, especially if it’s your first time doing it. Hopefully, this article has helped you understand what it is, how to calculate it, and which expenses you need to take into account!