Employer taxes (example rates)

An employee's gross pay is not the whole cost of employing them. The employer also owes its own payroll taxes on that pay, on top of it, and some of those taxes stop once an employee's wages for the year reach a limit. This page explains how employer taxes differ from withholding, works through a full payroll at example rates, and ends with the number managers ask about most: the total cost of each employee.

Employer taxes vs withholding

Payroll involves two very different kinds of tax, and mixing them up is the most common source of confusion:

• Withholding is taken out of the employee's pay. It lowers net pay. The employer only holds the money and passes it on.
• Employer taxes are the employer's own cost. They are not taken from the employee at all. They are paid on top of gross pay, so they raise the cost of the payroll without changing anyone's paycheck.

So an employee earning $4,219.34 gross sees withholding on their pay slip, but never sees the employer's taxes. The employer, on the other hand, pays both the $4,219.34 and its own taxes on it.

The example taxes

The exercises use three example taxes, each with an example rate. The names describe what such taxes are typically for, but the numbers are invented for practice:

Taxes 1 and 2 apply to every dollar of gross pay. Tax 3 has a wage base: it applies only to each employee's first $9,000.00 of wages in the year. Once an employee has been paid that much, tax 3 stops for them until the year starts again.

Taxes on every dollar: a straight rate

For a tax without a wage base, the calculation is gross pay times the rate, rounded to the cent. At Northside Print Shop, B. Chen earned $3,478.42 this period:

• Example tax 1 = $3,478.42 × 6.00% = $208.71
• Example tax 2 = $3,478.42 × 1.50% = $52.18

In a spreadsheet the rates sit in a small table to the side, and each formula refers to its rate with an absolute reference such as $J$4. Fill the formula down and every employee uses the same rate. Add a total row and you have the employer's bill for each tax.

A tax that stops at the wage base

The wage base is a yearly limit per employee, so you need to know how much each employee has already been paid this year. Then three questions settle it:

1. How much room is left? Wage base minus wages earlier this year.
2. How much of this period's pay fits in that room? The smaller of this period's pay and the room left.
3. Could it go negative? If an employee is already past the base, the room is negative. Taxable wages are then zero, never below.

As one formula: taxable for tax 3 = MAX(0, MIN(gross pay, wage base − wages earlier this year)). Then tax 3 = taxable × 0.80%, rounded to the cent.

Bluebird Veterinary shows all three cases in one payroll:

B. Chen is well below the base, so all of this period's pay is taxable. F. Larsen crosses the base during this period: only $1,415.79 of the $2,283.53 fits under $9,000.00, so only that part is taxed. G. Mensah passed the base long ago, so nothing is taxable and tax 3 is zero.

Worked example: total employer cost at Bluebird Veterinary

Now put it together. For each of Bluebird Veterinary's eight employees, work out all three example taxes, add them up, and add them to gross pay:

Take B. Chen's row step by step. Tax 1 = $4,219.34 × 6.00% = $253.16. Tax 2 = $4,219.34 × 1.50% = $63.29. Tax 3 = $4,219.34 × 0.80% = $33.75, because all of the pay is under the base. Employer taxes = $253.16 + $63.29 + $33.75 = $350.20. Total cost = $4,219.34 + $350.20 = $4,569.54.

The totals row tells the story for the whole period. Bluebird Veterinary paid $27,865.35 in gross wages, and on top of that owes $2,280.00 of its own example taxes, for a total payroll cost of $30,145.35. Check the totals the same way you check a row: $27,865.35 + $2,280.00 = $30,145.35, and $1,671.92 + $417.99 + $190.09 = $2,280.00.

Notice G. Mensah. Their gross pay is almost the same as D. Novak's, but their employer taxes are lower because tax 3 has stopped for them. Two employees on the same pay can cost the employer different amounts depending on where they are in the year.

Round each row, then total

Round every tax to the cent on its own row, then add the rounded amounts. The employer pays and records the rounded figures, so the total has to be the sum of what was actually charged. If you instead multiply the gross pay total by the rate, you can land a cent or two away from the column total, because the rounding happens in a different place. For Bluebird Veterinary, $27,865.35 × 6.00% is $1,671.921, which happens to round to the same $1,671.92, but on another payroll it may not. When the sheet and the books disagree by a cent, rounding in the wrong place is usually why.

The same rule explains why the exercises ask you to wrap each tax in ROUND before totalling. A column of unrounded results can display the right cents and still add up to a slightly different total.

Where employer taxes go in the books

Employer taxes are an expense of the period the wages were earned in, and a liability until they are paid. The entry is a debit to Payroll Tax Expense and a credit to Payroll Taxes Payable, with no cash moving yet. Keep them separate from the amounts withheld from employees. The full set of entries is in payroll journal entries, and the same calculations are set up as spreadsheet skills in employer payroll taxes in Excel.

Common mistakes

The exercises check for each of these and tell you which one you made.

A rate reference that moves when filled down

Writing =ROUND(D5*J4,2) and filling down makes the next row point at J5, then J6, then empty cells. Every employee uses the same example rate, so lock it: $J$4.

Using tax 1's rate for tax 2

Copying the tax 1 formula across without changing the rate gives B. Chen at Northside $208.71 for both taxes. Each tax has its own rate. Tax 2 is $52.18.

Ignoring the wage base

Charging tax 3 on all of F. Larsen's pay gives $2,283.53 × 0.80% = $18.27 instead of $11.33, and charging G. Mensah gives $25.88 instead of zero. Tax 3 stops once wages for the year reach the base.

Comparing the base with this period's pay only

Writing MIN(gross pay, wage base) treats every pay period as the start of the year. F. Larsen's $2,283.53 is under $9,000.00, so it would all look taxable. The wage base is for the whole year, so subtract the wages already paid this year first.

Leaving the wages out of total cost

Total cost is gross pay plus employer taxes. Reporting B. Chen's cost as $350.20 counts only the taxes. The cost of an employee is $4,569.54.

How to check your work

• Taxable wages for a capped tax are never more than gross pay and never below zero.
• Once an employee's earlier wages are at or above the base, their capped tax is zero.
• Employer taxes for each row equal the sum of the separate taxes, and total cost equals gross pay plus employer taxes.
• The column totals add up the same way the rows do.