How To Calculate Payroll Costs For Your Small Business 

A business owner’s main priority is to grow the business and build a team to meet goals. But with any business, time-consuming mandatory administration requirements like payroll are necessary.

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How To Calculate Payroll Costs For Your Small Business 

A business owner’s main priority is to grow the business and build a team to meet goals. But with any business, time-consuming mandatory administration requirements like payroll are necessary. According to the IRS, more than 40% of businesses are fined each year for failing to meet payroll tax obligations. Businesses with manual processes and disconnected software are at risk of miscalculations, incorrect filings, and late withholding deposits as a result of running payroll through manual processes and disconnected software. A payroll service may be an additional cost for your business, but it can save a lot of time and prevent non-compliance.

What are payroll costs?

Payroll is how you compensate employees for the work they do for your business, whether they are full-time or hourly. It’s vital to keep a close eye on your payroll expenditures and manage them carefully, since they often represent a company’s largest expense category.

Employers incur payroll expenses to compensate their workers. This extends far beyond regular salaries and wages. In addition to payroll taxes, FICA taxes, unemployment insurance contributions, and more, employers are also responsible for paying a portion of payroll taxes.

Other payroll costs can include bonuses, tips, commissions, and paid leaves, depending on the worker’s employment type. The labor cost of administering the payroll function also represents an expense for most businesses.

Types of Payroll Costs

Gross Wages: Hourly workers are paid with this portion of your payroll expenses. You can calculate gross wages by multiplying your employees’ hourly wage amount by the number of hours they worked during your payroll period. Pay overtime is calculated at an hourly rate of one and a half times your hourly wage.

Salaries: An employee’s salary is the salary earned per pay period, regardless of how many hours were worked.

Payroll Taxes: Payroll taxes are paid by employers to state and federal agencies based on their gross payroll. Social Security, Medicare, unemployment insurance, and industrial contributions fall into this category.

Tax Withholdings: Federal income taxes are withheld from employees’ paychecks as tax withholdings. Withholding amounts will vary depending on your employees’ income levels and their Form W-14 information.

Employee Benefits: If your company offers employee benefits, you will need to consider the following costs:

  • Insurance (health, dental, vision, life, and disability).
  • Paid leave (vacations and sick days).
  • 401(k), savings plans, or pension plans.
  • Post-retirement health insurance.

How To Calculate Labor Cost 

Labor costs are the largest expense for most businesses. All wages, benefits, and payroll taxes paid to and for employees are considered labor costs. It is imperative to pay attention to the labor cost percentage. This is because it indicates how efficiently your business converts labor into profit. 

How Much Does Labor Cost?

Different industries have different labor costs. However, there are some similarities that businesses can use to estimate labor costs.

In order to calculate labor costs, you have to consider the following:

  • Wages
  • Payroll taxes
  • Overtime
  • Bonuses
  • Health care
  • Sick days
  • Vacation days
  • Insurance
  • Benefits
  • Meals
  • Supplies
  • Training

How to Calculate Payroll Taxes

Payroll tax becomes your responsibility the moment you hire your first employee. Payroll tax does not refer to one single tax but rather to all wage taxes paid by employees.

As an employer, you will be responsible for:

  • Deducting taxes from employee wages to pay for certain expenses.
  • Withholding payroll taxes from your own revenue for each employee.

There are two types of payroll taxes: those you pay yourself and those you collect from employee paychecks and remit to the government.

Taxes paid by you:

  •  Federal Insurance Contributions Act (FICA) 

Social Security and healthcare programs such as Medicare are funded by contributions made by employees. Both the employer and the employee are responsible for sharing the cost of this service. Employers pay 6.2% of Social Security and 1.45% of Medicare, and their employees pay the same amount.

  • Federal Unemployment Tax Act (FUTA) 

Unemployment insurance contributions are an instrumental part of our social security system. There is a total amount of 6.0% to pay. Most states, however, have a 5.4% credit, which means that most employers only have to pay 0.6% of the tax.

  • State Unemployment Tax Act (SUTA)

SUTA taxes are also known as reemployment taxes. As your state sets these rates, you’ll need to check with your state specifically for guidelines and adjust your contributions accordingly. 

Taxes paid by your employees that you collect and remit on their behalf:

  • Federal income taxes

Employers withhold income tax on behalf of their employees and remit it to the government on a quarterly basis. In addition to Form W-4, you’ll need your employee’s gross pay to determine how much federal income tax to withhold. Choosing the method for calculating withholding is your next step. Wage brackets or percentages are the two most common methods used by employers.

  • State and local taxes

State and local income taxes are based on the amount of income you earn and the tax rate in the state or locality where you live.

Payroll Tax Withholding Calculator

If you don’t use an online payroll calculator, you may find yourself guessing as you answer questions such as:

  • What amount should you deduct from an employee’s paycheck?
  • What taxes are required, and how do they affect payroll?
  • What is the impact of post-tax reimbursements on the payroll?

The IRS has a tool to estimate the federal income tax you want your employer to withhold from your paycheck, which is tax withholding. Calculate your refund, take-home pay, and tax due based on your withholding. It is important to note that the results are only as accurate as the information you provide.

 Using this tool, you can:

  • Calculate your federal income tax withholding.
  • Find out how your refund, take-home pay, or tax due is affected by withholding.
  • Estimate your withholding amount based on your needs.

You’ll need to provide your pay stubs for all jobs, and any other other income info as well as your most recent tax return.

How to Calculate Total Payroll Costs

Making Payroll Calculations for Hourly Employees

Collecting time records is the first step for paying hourly employees. For payroll submission, some companies use timesheets, while others use time clocks. Each pay period, whoever supervises an hourly employee submits the time records to the bookkeeper or payroll company

Once timesheets have been collected, payroll can be calculated.

For example, if a nonexempt employee works a standard 40-hour week and has an hourly salary of $15 per hour, you would calculate gross pay with a formula.

40 hours worked x $15 per hour = $600

Calculating Payroll for Salaried Employees

Paying salaried employees is a simpler process. A salaried employee’s base salary and the number of pay periods per year are all you need to know.

Typically, employers can pay their employees in four different pay frequencies: monthly, semimonthly, biweekly, or weekly. Most commonly, semi-monthly or biweekly frequencies are used, but it is up to the employer.

Employment Taxes

The employer still owes the following taxes after paying hourly wages, salaries, and bonuses to each employee.

  • Social Security/FICA – Currently 6.2% on the first $90,000 of salary
  • Unemployment/FUTA – Currently 6.2% on $7,500 of salary
  • Medicare – Currently 1.45% with no salary cap
  • Workman’s compensation – Varies depending on the category of your employee, with clerical at about 0.3% of salary and manufacturing at about 7.5% of salary


Basic salary and employment taxes are the minimum. The employer has the discretion to offer benefits. In most cases, the employer will have to offer at least some benefits in order to attract and retain quality employees.

Life insurance, health insurance, and some dental coverage are typical benefits for a $50,000 salaried employee. In addition, long-term disability insurance, tuition reimbursement, and retirement plans such as IRAs, 401(k)s, etc. may be available.

How to Calculate A Total Employee Cost

An employee’s total cost depends on their benefits package, which typically ranges from 25-40% of their salary. On average, it would cost a business somewhere between $62,500 and $70,000 to hire an employee with a $50,000 salary. 

Milestone Takes The Stress Out of Payroll

At Milestone, we want you to be able to sleep easy knowing that your payroll service is taken care of correctly. There is no margin for error when it comes to payroll processing. Our payroll experts will use the best tools to design the right process to ensure that your employees are paid on time and that you remain compliant with local and federal laws. Contact us today to see how we can help your small business save time and money.

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