So, you want to learn
Bookkeeping!
Payroll
by Bean Counter's Dave Marshall

Lesson 3
Calculating Payroll


Introduction Lesson 1 Lesson 2 Lesson 3 Lesson 4 Lesson 5 Lesson 6 Lesson 7 Lesson 8
Bean Counter
Now that we've covered the types of compensation and typical payroll deductions in prior lessons, we need to combine the two and throw in some additional concepts and practical examples to see how we actually perform payroll calculations. Our calculations also need to abide by any applicable federal or state laws.

The total earnings of an employee prior to any deductions is called gross pay or gross earnings. The gross pay minus the legal and authorized deductions is called net pay. Our examples will include the major types of compensation such as salaries, hourly wages, piece rate wages, overtime, tips, and bonuses. In addition, our examples will illustrate how and where to get the information necessary to calculate the different types of payroll deductions. Additionally, we'll discuss any areas (earnings or deductions) where federal or state laws may apply.

Since the best way to learn about calculating payroll is actually doing, that's exactly the approach we're going to take. We're going to use a restaurant (Mom's Secret Recipes) as our example type of business so that we can also include some examples of tipped employees. For those businesses that don't have to deal with tips, the extra bit of knowledge won't hurt.

Payroll Assumptions and Rules regarding Mom's Secret Recipes:

  • We're organized as a sole proprietorship.
  • We'll use the rates for social security and medicare in effect for the year 2005.
    Social Security - 6.2 % or .062
    Medicare - 1.45 % or .0145
  • We'll use the IRS's income tax withholding tables and calculations in effect for the 2005 year.
  • We'll assume our state has a state income tax and that state income tax is withheld at a flat rate of 10% of gross pay. Note:Actually states publish withholding tables and calculations similar to the IRS withholding tables.
  • We live in a locality that has no city income tax.
  • Our restaurant is subject to the Fair Labor Standards Act (FLSA) -minimum wage and overtime laws.
    The Fair Labor Standards Act (FLSA) as of 2004 sets a federal minimum wage of $5.15 per hour for covered, nonexempt employees. An employer of a tipped employee is only required to pay $2.13 ($5.15 -3.02 tip credit) an hour in direct wages if that amount plus the tips received equals at least the federal minimum wage, the employee retains all tips and the employee customarily and regularly receives more than $30 a month in tips. If an employee's tips combined with the employer's direct wages of at least $2.13 an hour do not equal the federal minimum hourly wage, the employer must make up the difference.

Some states have minimum wage and/or overtime laws that differ from the federal law. When an employee is subject to both the federal and state wage laws, the employee is entitled to the provisions which provide the greater benefits.

  • Our state as well as the federal government allows us a "maximum tip credit" of $3.02 and our state's minimum wage is the same as the federal minimum wage of $5.15. In addition, all our tipped employees comply with any additional federal laws.
  • All our employees have signed an agreement where if the need arises where their earnings are not enough to cover all authorized deductions from their pay that we may require them to setup and deposit funds in order to cover these deductions or reimburse us each pay period that this situation occurs.
  • Our chef and cooks salaries are based on a 45 hour work week. We do not dock salaries for days off or tardiness. In other words if our cooks and chefs work less than 45 hours we still pay them their full salary.
  • All our employees are married.
  • Our restaurant pays 50% of a family's premium for health insurance and our plan qualifies with the IRS for tax-exempt treatment. The annual premium for our family plan is $5,200.
  • We provide one week of vacation for all employees with at least 6 months of company service and two weeks for all employees with a year or more of company service. All our current employees qualify for two weeks.
  • We provide 5 paid holidays a year for all employees with at least 6 months of company service. All our current employees qualify for the 5 holidays.
  • We provide 5 sick days paid a year for all employees with over 6 months company service. All our current employees qualify for the 5 sick days.
  • Our state requires a 30 minute "lunch" break for all employees scheduled to work more than 6 hours during a day. In addition, we provide two 10 minute paid breaks during the work day.
  • We include any bonuses with regular wages. In other words we don't issue separate checks for bonuses.
  • For the convenience of our employee's we administer an employee savings account and U.S. Savings Bond programs.
  • We hold our waiters and waitresses responsible and accountable for 50% of any bills (tabs) the customer left without paying. In other words we share the cost of "walked tabs". All our waiters and waitresses have signed a statement authorizing this "special" deduction.
    Note: Ma's accountant (me) discusses this with Ma later in this lesson.
  • We require our tipped employees to report their tips each week.
  • We hold our dishwashers responsible for broken dishes. All our dishwashers have signed a statement authorizing this "special" deduction.
    Note: Ma's accountant (me) discusses this with Ma later in this lesson.
  • We require all our employees to have "uniforms"- embroidered shirts with the our name and logo. We supply the first three at no cost and the employee is responsible for purchasing additional shirts that are lost or worn out. All our employees have signed a statement authorizing this "special" deduction.
  • All our employees have been instructed about employee deductions and have signed our "blanket" employee deduction authorization form.
  • All our food handlers are subject to periodic health exams. We pay 100% of the cost of these required exams.

What should you pick up from reviewing our assumptions ?

  • We've established policies such as "special deductions".
  • We've done our research to determine if any special requirements apply to our type of business- health exams for food handlers and tips must be reported by our tipped employees.
  • We've done our homework as to what deductions are required by federal, state, or local laws.
  • We've set up fringe benefits such as insurance and paid holidays and vacations - not required by law but we want to be competitive in attracting good employees.
  • We've obtained "blanket" and "special" authorizations for deductions from our employee's pay.
  • We used salary as the payment method for some of our nonexempt employees. Normally nonexempt employees are paid on an hourly or other basis but the labor laws also allow you as an employer to use the salary payment method for nonexempt employees if you want to. We based our chef and cook salaries on a 45 hour work week. This is perfectly legal although many small businesses don't realize it.

Although not required, I recommend that even a small business with employees prepare an employee's manual (it doesn't have to be fancy) that contains your employee policies and prepare job descriptions. By doing this, everyone should know what to expect.

  • Our Employee Job Categories:
Name Method Of Pay
Dishwashers Hourly
Sales-Banquets Commission
Waiters/Waitresses Hourly + Tips
Head Chefs Salary / Bonus
Chefs Salary
Cooks Salary
Line Helpers Hourly
Food Preparers (Prep) Piece Rate
Cashier Hourly
Managers Salary / Bonus
  • Our Current Employee Information
Employee Name W-4
Exemptions
Job Description Method of Pay Pay Rate Pay Period
Fat Chef M-3
Married
3 Exemptions
Head Chef Salary + Bonus $1,300 every 2 - weeks
or $650 every week
Note: Based on 45 hours
each week
Bi-Weekly
(every two weeks)
Notbad Cook M-1 Cook Salary $800 every 2 - weeks
or $400 every week
Note: Based on 45 hours
each week
Bi-Weekly
Goodwith Cash M-2 Cashier Hourly $6.00 Weekly
Wet Hands M-1 Dishwasher Hourly $5.15 Weekly
Good Waitress M-1 Waitress Hourly + Tips $7.00 Weekly
Handsome Waiter M-2 Waiter Hourly + Tips $2.13 ($5.15-3.02) Weekly
Knowit All M-2 Manager Salary + Bonus $3,000 Monthly
Betty Baker M-3 Food
Preparation
Piece Rate Various Rates Weekly
Line Man M-1 Line Helper Hourly $7.50 Weekly
Talk Alot M-1 Sales Commission 20 % of Sales
Banquets & Special Events
Weekly
Mom Toall N/A Owner Draws Various Various

What should you pick up from reviewing our job categories and employee list ?

  • You can establish different pay periods for different employee job categories.
  • You can have different methods of calculating pay for different employee job categories.
  • We've used our allowed maximum tip credit of $3.02 in determining the $2.13 ($5.15 - 3.02) rate per hour for Handsome Waiter.
  • Since Mom's organized as a sole proprietorship she is not included in payroll. Instead she receives draws. Mom is not actually considered an employee. We'll discuss Ma in a later Lesson.

Let's first classify our employees as exempt or nonexempt as required by the Fair Labor Standards Act. Let's do the easy part first. Any worker that is not paid a salary is automatically classified as nonexempt.

What exactly is a salary ? Salaries-compensation based on a fixed amount and paid to an employee for management, professional, administrative, or similar services (exempt type of jobs). A salary is usually stated in terms of a weekly, monthly, or yearly amount. Note: Although salaries are normally used to pay for the so called exempt types of jobs, they may also be used as the payment method for skilled or unskilled employees in non management or supervisory jobs , the so called nonexempt types of jobs. With a "true" salaried position the employee is paid the same amount regardless of how many hours the employee actually works during the pay period.

Don't be led astray, just because an employee is paid by the salary method does not necessarily mean you don't have to pay that employee overtime. If the employee is also exempt you don't have to pay overtime; however, if the employee is nonexempt you are required by law to pay overtime.

So based on this, our Nonexempt Employees (those not paid by the salary method) include:

  • Goodwith Cash
  • Wet Hands
  • Good Waitress
  • Handsome Waiter
  • Line Man
  • Betty Baker
  • Talk Alot

For employees that we're paying a salary we need to see what type of job and the duties and tasks that the employee performs and if their salary is greater than $455 a week in order to determine if the employee is exempt or nonexempt. In general, all administrative and managerial type of jobs are exempt. Since Knowit All's job is the manager and he makes more than $455 per week, he falls under the exempt category.

Exempt Employees:

  • Knowit All

Fat Chef's salary stated on a weekly basis is $650 which is greater than the $455 a week needed to qualify as an exempt employee; however, his job duties do not qualify for the exempt status.

Notbad Cook's salary stated on a weekly basis is $400 which is less than the $455 a week needed to qualify as an exempt employee. We don't have to analyze his job duties because based on his salary he is already classified as a nonexempt employee. Although Fat Chef and Notbad Cook are paid a salary their job duties and/or salary amounts do not qualify them for an exempt status.

Additional Nonexempt Employees:

  • Fat Chef
  • Notbad Cook

You should note that our only exempt employee (not subject to the laws and regulations of the Fair Labor Standards Act) is our manager. All the rest of our employees are covered.

Note:New labor laws and regulations regarding exempt employees went into effect in 2004. If you already own a business you should check them out in order to make sure your business is complying with the new laws.

I think Ma's employees are getting impatient and want their checks so Ma (who does the payroll) better gather up the information and get out her pencil, calculator, and tax tables .

What information does Ma need in order to properly calculate her payroll ?

  • Regular and Overtime Hours Worked , Production of Pastries, Bonus Calculations, and Reported Tips.
    Ma uses a time clock to record the time worked for all her employees except the manager and cooks who fill out a weekly time sheet and in addition any preparation employees also fill out a daily production report (number of pastries made) and tipped employees fill out a weekly report of tips received.

Hours Worked and To be Paid

Employee Total Hours
Worked
Regular Hours Overtime Hours Vacation / Sick
Fat Chef 85 80
1st wk- 40 hrs
2nd wk- 40 hrs
5
1st wk- 3 hrs
2nd wk- 2 hrs
 
Notbad Cook 88 78
1st wk -38 hrs
2nd wk -40 hrs
10
1st wk- 0 hrs
2nd wk- 10 hrs
 
Goodwith Cash 35 35 0 8
Wet Hands 42 40 2  
Good Waitress 45 40 5  
Handsome Waiter 50 40 10  
Knowit All 200 200 Included in
Regular Hrs
8
Betty Baker 45 40 5  
Line Man 40 40 0  
Talk Alot 40 40 0  

Other Employee Payroll Information

  • Piece Work Quantities for Betty Baker.
    Betty gets paid $1.00 for each desert item she bakes. Betty produced 175 deserts during the week.
  • Banquet and Special Event Sales during the pay period.
    Talk Alot had 4 banquets and/or special events booked during the pay period with total sales amounting to $1000.
  • Any Employee Vacation , Sick Days, or Holidays that need to be paid.
    Our cashier Goodwith Cash was off one day due to sickness and Mom had to run the register. Ma checked and Goodwith Cash hadn't used any of her 5 days allowed.
    Also our manager Knowit All took one day off for vacation. Ma checked and he still had 7 days remaining.
  • Report of tips received during the pay period for Good Waitress and Handsome Waiter.
    Good Waitress reported tips amounting to $250 during the period.
    Handsome Waiter reported tips amounting to only $50 during the period. I guess he didn't impress the lady customers that much.
  • Cash Shortages, Broken Items, and Walked Tabs during the pay period. Ma just started these new policies. In the past, she did not hold her employees responsible for any of the cost.
    Friday was a hectic evening and Goodwith Cash had a cash shortage of $25 for the night.
    Wet Hands (should have been named Slippery Hands) broke 10 plates at a cost of $3.00 a piece- his share of the breakage cost is $1.50 for 10 plates for a total amount of $15.
    Good Waitress and Handsome Waiter both had customers leave without paying their bills. Handsome Waiter had total walked tabs amounting to $100.00 and Good Waitress had total walked tabs amounting to $50.00. Since they pay half Good Waitress has a deduction amounting to $25 and Handsome Waiter a deduction amounting to $50.
  • Our manager's bonus is based on a 1/2% of the current monthly sales and our chef's a 1/4% commission of the sales for the current two-week pay period. The sales for the month amounted to $100,000 and the sales for the current two week period amounted to $50,000.

Knowit All's Bonus- $500 (1/2 % x $100,000)

Fat Chef's Bonus- $125 (1/4 % x $50,000)
The sales during the first week were $23,000 and the sales for the second week were $27,000.

  • Employee deduction amounts for insurance.
    Employee's Share (50%) - $5200/52 x .5 = $50 per week
    Paid Weekly Employees- $50 Paid Bi-Weekly Employees- $100 Paid Monthly Employees- $217
  • Deduction amounts for employee bonds or savings accounts. Only the Chef-Fat Chef, Cook-Notbad Cook, and Manager-Knowit All have signed up for and authorized a deduction for bonds and/or savings.
    Knowit All- Manager - $25 savings deduction $25 bond deduction per pay period.
    Fat Chef- Chef - $25 bond deduction per pay period.
    Notbad Cook- $20 savings deduction per pay period.
  • Fat Chef purchases a new shirt (uniform) costing $25.00 during the pay period.

Where did Ma get all this payroll information from ?
Ma designed forms to record days off, employee tips, breakage, cash shortages, walk out tabs , and employee authorization forms for other deductions. Ma's pretty smart and also saves time by keeping an employee summary deduction sheet with the name of each employee and all the normal recurring employee deductions for each employee so that she doesn't have to go to the employee's payroll file each pay period to find out what deductions and how much to deduct from an employee's pay each pay period.

Gross Earnings

Our first step is calculating our employee's Gross Earnings. In other words, we need to use the hours and other employee payroll information to calculate our employee's earnings prior to any deductions.

Employee Pay Period Regular
Earnings
Overtime
Earnings
(B)-Bonuses
(T)-Tips
(C)-Commissions
(S)-Sick
(V)-Vacation
Total
Gross
(1) Fat Chef Bi-weekly $1,300.00
1st wk- 650
2nd wk- 650
36.10
1st wk- 21.66
2nd wk- 14.44
125 - (B)
 
 
  $1,461.10
 
 
(2) Notbad Cook Bi-weekly $800.00
1st wk- 400
2nd wk- 400
88.95
1st wk - 0
2nd wk - 88.95
    $888.95
 
 
(3) Goodwith Cash Weekly $210.00     48 - (S) $258.00
(4) Wet Hands Weekly $206.00 15.46     $221.46
(5) Good Waitress Weekly $280.00 52.50 250 - (T)   $582.50
(6) Handsome Waiter Weekly $166.00 67.30 50 - (T)   $283.30
(7) Knowit All Monthly $2,861.52   500 - (B) 138.48 - (V) $3,500.00
(8) Betty Baker Weekly $206.00 38.65     $244.65
(9) Line Man Weekly $300.00       $300.00
(10) Talk Alot Weekly $206.00       $206.00

Let's review the calculations of what makes up gross pay for each employee.

(1) Fat Chef

  • Fat Chef is paid by the salary method and his salary is based on working up to 45 hours a week as agreed upon with Ma. If he works less than 45 he is also paid the same amount; however, since he is a nonexempt employee if he works over 40 hours during a pay week he must be paid overtime for all hours worked over 40. Fat Chef is also entitled to a bonus. The law basically requires all types of remuneration to be included in calculating an employee's regular and overtime rates. In our case, we need to include our chef's bonus in our calculations.
  • Our first step is to calculate Fat Chef's bonus for the two week pay period. Fat Chef's bonus is based on a rate of 1/4 % of the sales during the two week pay period - $50,000. The sales during the first week were $23,000 and the sales for the second week were $27,000. This calculation is simple. Just multiply the bonus rate times the sales for the period.

Bonus 1st Week = Sales X Bonus Rate
Bonus 1st Week = $23,000 X 1/4 %
Bonus 1st Week = $57.50

Bonus 2nd Week = Sales X Bonus Rate
Bonus 2nd Week = $27,000 X 1/4 %
Bonus 2nd Week = $67.50

Total Bonus = Bonus 1st Week + Bonus 2nd Week
Total Bonus = $57.50 + 67.50
Total Bonus = $125.00

  • In order to calculate what to pay him for any overtime, we first need to calculate what his straight time rate of pay per hour is. We do this by dividing his weekly Salary amount of $650 a week plus his Bonus for the week by the number of hours his pay is based upon.
    Calculation of 1st Weeks Pay
    Straight Time Rate = (Salary + Bonus) / Hours Salary Based On
    Straight Time Rate Per Hour = ($650 + $57.50) / 45 hours
    Straight Time Rate Per Hour = $15.72 per hour
  • Our next step is to calculate what his overtime rate of pay per hour is. Ma pays 1/1/2 times the straight time rate for overtime hours. So all we need to do is multiply his straight time rate per hour time 1.5.

Overtime Rate Per Hour = Straight Time Rate Per Hour X 1.5
Overtime Rate Per Hour = $15.72 x 1.5
Overtime Rate Per Hour = $23.58

The overtime rate per hour is actually made up of the straight time rate of $15.72 plus what is often called the premium portion of $7.86. All we're saying here is that Fat Chef makes an additional $7.86 an hour when he works overtime. A simple way of determining the premium portion is subtracting the Straight Time Rate Per Hour from the Overtime Rate Per Hour.
Premium Rate Per Hour = Overtime Rate Per Hour - Straight Time Rate Per Hour
Premium Rate Per Hour = $23.58 - 15.72
Premium Rate Per Hour = $7.86

  • Next we need to get and review Fat Chef's actually hours worked for each week of his two week payroll period.
    Week 1 - 43 hours worked
    Week 2 - 42 hours worked

Do we need to pay Fat Chef for any overtime hours for either or both weeks ? We sure do, he worked over 40 hours during both weeks.

  • Now that we have the rates and hours and bonus, all we need to do is pay Fat Chef his base salary and bonus and pay his overtime hours at his overtime rate of $23.58 - right ?

Week 1 Calculation:
Base Salary = $650.00

Bonus For Week = $57.50

Overtime Hours = Total Hours Worked - 40
Overtime Hours = 43 -40
Overtime Hours = 3

Overtime Pay = Overtime Rate x Overtime Hours
Overtime Pay = $23.58 x 3
Overtime Pay = $70.74

Total Pay For Week 1 = Base Salary + Bonus + Overtime Pay
Total Pay For Week 1 = $650.00 + 57.50 + 70.74
Total Pay For Week = $778.24

Wrong ! Since Fat Chef's salary is based on a 45 hour work week the calculation of his overtime is a little different. Why ? Because for any overtime hours worked between 40 - 45 hours we have already paid him his straight time rate for up to 5 hours. All we owe him for the overtime hours worked between 40 - 45 hours is the premium portion or $7.86 per hour to get his pay for these hours up to the $23.58 overtime rate. What about any overtime hours that exceed 45 hours ? In that case, we would have had to pay any overtime hours that exceeded 45 hours at his full overtime rate of $23.58.

Week 1 Correct Calculation:
Base Salary = $650.00

Bonus For Week = $57.50

Overtime Pay
Overtime Hours = Total Hours Worked - 40
Overtime Hours = 43 -40
Overtime Hours = 3

Additional Overtime Pay = Overtime Hours x Overtime Premium
Additional Overtime Pay = 3 x $7.86
Additional Overtime Pay = $23.58

Total Regular Earnings Week 1
Total Week 1 Pay = Base Salary + Bonus + Overtime
Total Week 1 Pay = $650.00 + 57.50 + 23.58
Total Week 1 Pay = $731.08

Week 2 Correct Calculation:
Base Salary = $650.00

Bonus For Week = $67.50

Straight Time Rate Per Hour = ($650 + $67.50) / 45 hours
Straight Time Rate Per Hour = $15.94 per hour

Overtime Rate Per Hour = Straight Time Rate Per Hour X 1.5
Overtime Rate Per Hour = $15.94 x 1.5
Overtime Rate Per Hour = $23.91
Overtime Premium = $23.91 - 15.94
Overtime Premium = $7.37

Overtime Pay
Overtime Hours = Total Hours Worked - 40
Overtime Hours = 42 -40
Overtime Hours = 2

Additional Overtime Pay = Overtime Hours x Overtime Premium
Additional Overtime Pay = 2 x $7.37
Additional Overtime Pay = $15.94

Total Regular Earnings Week 2
Total Week 2 Pay = Base Salary + Bonus +Overtime
Total Week 2 Pay = $650.00 + 67.50 + 15.94
Total Week 2 Pay = $733.44

Total Earnings For 2 Week Pay Period
Total Earnings = Week 1 + Week 2
Total Earnings = $731.08 + 733.44
Total Earnings = $1,464.52

(2) Notbad Cook

  • Notbad Cook, like Fat Chef, is also paid by the salary method and his salary is also based on working up to 45 hours a week as agreed upon with Ma. If he works less than 45 he is also paid the same amount; however, since he is a nonexempt employee if he works over 40 hours during a pay week he must be paid overtime for all hours worked over 40.

Calculating his pay should be a breeze since his calculations are very similar to Fat Chef's. Good Chef however does not receive a bonus.

  • In order to calculate what to pay him for any overtime, we first need to calculate what his straight time rate of pay per hour is. We do this by dividing his weekly salary amount of $400 a week by the number of hours his pay is based upon.
    Straight Time Rate Per Hour = $400 / 45 hours
    Straight Time Rate Per Hour = $8.89 per hour
  • Our next step is to calculate what his overtime rate of pay per hour is. Ma pays 1/1/2 times the straight time rate for overtime hours. So all we need to do is multiply his straight time rate per hour time 1.5.

Overtime Rate Per Hour = Straight Time Rate Per Hour X 1.5
Overtime Rate Per Hour = $8.89 x 1.5
Overtime Rate Per Hour = $13.34

The overtime rate per hour is actually made up of the straight time rate of $8.89 plus what is often called the premium portion of $4.45. All we're saying here is that Fat Chef makes an additional $4.55 an hour when he works overtime. A simple way of determining the premium portion is subtracting the Straight Time Rate Per Hour from the Overtime Rate Per Hour.
Premium Rate Per Hour = Overtime Rate Per Hour - Straight Time Rate Per Hour
Premium Rate Per Hour = $13.34 - 8.89
Premium Rate Per Hour = $4.45

  • Next we need to get and review Notbad Cook's actually hours worked for each week of his two week payroll period.
    Week 1 - 38 hours worked
    Week 2 - 50 hours worked

Week 1 Calculation:
Base Salary = $400.00

Overtime Pay
No Hours Worked over 40 -No Overtime Hours

No Additional Overtime Pay

Total Regular Earnings Week 1
Total Week 1 Pay = Base Salary + Overtime
Total Week 1 Pay = $400.00 + 0
Total Week 1 Pay = $400.00

Did you notice that although Notbad Cook only actually worked 38 hours during week 1 that he was paid his full weekly salary of $400.00. ?

Week 2 Calculation:
Base Salary = $400.00

Overtime Pay
Overtime Hours = Total Hours Worked - 40
Overtime Hours = 50 -40
Overtime Hours = 10

Overtime Calculation in Good Cook's case will involve two calculations. One for the overtime hours worked up to and including 45 hours and another for the overtime hours worked over 45 hours. Can you tell me why ? Because Good Cook's salary is based on working a 45 hour work week. In effect his salary already includes the straight time rate for working up to 45 hours.

Additional Overtime Pay For Hours From 40 - 45 = Overtime Hours x Overtime Premium
Additional Overtime Pay For Hours From 40 - 45 = 5 x $4.45
Additional Overtime Pay For Hours From 40 - 45 = $22.25

Additional Overtime Pay For Hours From 45 - 50 = Overtime Hours x Full Overtime Rate
Additional Overtime Pay For Hours From 45 - 50 = 5 x $13.34
Additional Overtime Pay For Hours From 45 - 50 = $66.70

Total Overtime Pay = Pay For Hours From 40 - 45 + Pay For Hours From 45 - 50
Total Overtime Pay = $22.25 + 66.70
Total Overtime Pay = $88.95

Total Regular Earnings Week 2
Total Week 2 Pay = Base Salary + Overtime
Total Week 2 Pay = $400.00 + 88.95
Total Week 2 Pay = $488.95

Total Regular Earnings For 2 Week Pay Period
Total Regular Earnings = Week 1 + Week 2
Total Regular Earnings = $400.00 + 488.95
Total Regular Earnings = $888.95
or Total Regular Earnings = Salary (2 - Weeks) + Overtime (2 - Weeks)
Total Regular Earnings = $800.00 + 88.95
Total Regular Earnings = $888.95

Total Pay For 2 - Week Period (Gross) - $888.95

(3) Goodwith Cash

  • Our calculation of our cashier's pay is fairly straight forward since she's paid a $6.00 hourly rate except that Ma wants to be able to track how much sick and vacation time costs her each year. Remember Goodwith was out one day due to sickness.
  • Our first step in calculating her pay for the week is analyzing her hours in order to see if we need to pay her any overtime for more than 40 hours worked during the week. Goodwith Cash only actually worked 35 hours but was also off sick one day ( 8 hours). Since Ma pays for days off sick her total hours paid for the week are 43 hours.

Do we need to pay her 3 hours of overtime ? I tried to trick you - overtime is only based on actual hours worked and does not include holiday or vacation time not actually worked. So, the answer is no we don't have to pay her any overtime. Goodwith Cash's actual hours worked are only 35 hours.
Note:If a holiday was actually worked, the hours would be included in the determination if any overtime hours were worked.

  • All we need to do is multiply her hours times her hourly rate to calculate her earnings (gross) for the week. We do however need to break it out between sick time and regular earnings because although not required, Ma wants to keep track of how much sick days are costing her.

Regular Earnings = Hours Worked x Hourly Rate
Regular Earnings = 35 hours x $6.00
Regular Earnings = $210.00

Sick Time Pay = Sick Time Hours x Hourly Rate
Sick Time Pay = 8 hours x $6.00
Sick Time Pay = $48.00

Total Pay For Week - $258.00

(4) Wet Hands

  • Let's see if we need to pay our dishwasher any overtime. Our dishwasher is only paid $5.15 an hour (current minimum wage ) and worked 42 hours during the week. Since he worked over 40 hours we need to pay him for 2 hours at his overtime rate of pay.
  • Now let's calculate his overtime rate.
    Overtime Rate = 1.5 X Regular Rate
    Overtime Rate = 1.5 X $5.15
    Overtime Rate = $7.73
  • Now all we need to do is calculate the regular and overtime earnings and we've got it made.
    Regular Earnings = Regular Hours X Regular Rate
    Regular Earnings = 40 hours X $5.15
    Regular Earnings = $206.00

Overtime Earnings = Overtime Hours X Overtime Rate
Overtime Earnings = 2 hours X $7.73
Overtime Earnings = $15.46

Total Earnings = Regular Earnings + Overtime Earnings
Total Earnings = $206.00 + 15.46
Total Earnings (Gross) = $221.46

(5) Good Waitress

  • Good Waitress is one of Ma's tipped employees and Ma requires her to report the tips received from her customers each week. She had an excellent week and reported tips received amounting to $250.00 for the week.

Although by law, Ma could legally only pay her "out of pocket wages" of $2.13 ($5.15 -3.02) per hour as long as her reported tips equal or exceed the maximum tip credit of $3.02 per hour, she's such a great waitress that Ma, although not required to, pays her $7.00 an hour.

  • Our first step is determine if Good Waitress worked any overtime hours during the week. Her time card shows that she worked a total of 45 hours during the week and is entitled to 5 (45-40) hours of overtime pay.
  • Next we need to calculate her overtime rate of pay.
    Overtime Rate Per Hour = Straight Time Rate X 1.5
    Overtime Rate Per Hour = $7.00 X 1.5
    Overtime Rate Per Hour = $10.50
  • Now that we have her rates, let's do our math and calculate her regular and overtime earnings.
    Regular Earnings = Straight Time Rate X Straight Time Hours
    Regular Earnings = $7.00 X 40 hours
    Regular Earnings = $280.00

Overtime Earnings = Overtime Rate X Overtime Hours
Overtime Earnings = $10.50 X 5 hours
Overtime Earnings = $52.50

Total Earnings Paid By Ma = Regular Earnings + Overtime Earnings
Total Earnings Paid By Ma = $280.00 + 52.50
Total Earnings Paid By Ma = $332.50

Are we done yet ? You know better, Ma must now account for Good Waitress's Reported Tips. Although Ma did not actually pay Good Waitress's Tips amounting to $250, her customers did, Ma is required by law to include Good Waitress's Tips in her Gross Wages in order to calculate Good Waitress's social security, medicare, and income tax withholdings. Note: Ma also has to match and pay her employer's share of social security and medicare based on Good Waitress's total gross pay including her reported tips.

  • Our final step is to determine Good Waitress's Total Earnings (Gross) including her reported tips.
    Total Earnings Including Tips = Total Earnings Paid By Ma + Reported Tips
    Total Earnings Including Tips = $332.50 + 250.00
    Total Earnings Including Tips = $582.50

(6) Handsome Waiter

  • Handsome Waiter is our other tipped employee. Although good looking, he's relatively new and inexperienced and Ma only pays him the required $2.03 rate per hour when his reported tips equal or exceed the $3.02 an hour tip credit.
  • First, let's see if we owe Handsome Waiter any overtime pay. After checking Handsome's time card Ma determined that Handsome worked 50 hours during the week. Your turn - do we owe him any overtime pay ? Since Handsome worked more than 40 hours during the week we have to pay him for 10 hours of overtime.

In addition Handsome reported $50 of tips received for the week. Not a very good week when compared to Good Waitress's reported tips of $250.00.

  • First we need to convert his tips reported to an hourly basis or calculate his Tip Rate Per Hour.
    Tip Rate Per Hour = Reported Tips / Actual Hours Worked
    Tip Rate Per Hour - $50.00 / 50 hours
    Tip Rate Per Hour = $1.00

The law states that Ma has to pay at least $5.15 an hour and can use a maximum tip credit of $3.02 per hour if the actual tip rate per hour equals or is greater than $3.02 per hour to offset this rate. If the actual tip rate per hour is less than $3.02 an hour Ma is only allowed to use the actual tip rate per hour to reduce her required "out of pocket" wages paid.

So, for Handsome's straight time hours Ma has to pay him $4.15 an our "out of pocket".
Out Of Pocket Straight Time Rate =Minimum Wage Rate - Tip Credit
Out Of Pocket Straight Time Rate = $5.15 -1.00
Out Of Pocket Straight Time Rate = $4.15

  • Since we need to pay him overtime, we need to calculate his overtime pay rate. We know that the required overtime rate is determined by multiplying an employee's straight time rate times 1.5. Our question is what is Handsome Waiter's straight time rate. Is it $2.03 an hour ? No, although the tip credit is used to calculate an employer's "out of pocket" payment the employee must by law make at least a $5.15 an hour straight time rate including tips up to $3.02 an hour and be paid at least 1.5 times his straight time rate for any hours worked over 40.

Overtime Rate Per Hour = Straight Time Rate X 1.5
Overtime Rate Per Hour = $5.15 X 1.5
Overtime Rate Per Hour = $7.73

The law also allows an employer to reduce the overtime rate per hour with the tip credit. Our calculated tip credit for the current week was $1.00 an hour.
Overtime Rate Including Tip Credit = Overtime Rate Per Hour - Tip Credit Rate Per Hour
Overtime Rate Including Tip Credit = $7.73 - 1.00
Overtime Rate Per Hour = $6.73

  • Now that we have our rates calculated, all we need to do is do our math.
    Regular Earnings = Out Of Pocket Straight Time Rate X Straight Time Hours
    Regular Earnings = $4.15 X 40 hours
    Regular Earnings = $166.00

Overtime Earnings = Out Of Pocket Overtime Rate X Overtime Hours
Overtime Earnings = $6.73 X 10 hours
Overtime Earnings = $67.30

Total Earnings Paid By Ma = Regular Earnings + Overtime Earnings
Total Earnings Paid By Ma = $166.00 + 67.30
Total Earnings Paid By Ma = $233.30

  • Our final step is to determine Handsome Waiter's Total Earnings (Gross) including his reported tips.
    Total Earnings Including Tips = Total Earnings Paid By Ma + Reported Tips
    Total Earnings Including Tips = $233.30 + 50.00
    Total Earnings Including Tips = $283.30

(7) Knowit All

  • Knowit All is Ma's only exempt employee and is paid a salary of $3,000 a month or $36,000 on an annual basis. In addition to his salary he is also paid a bonus of 1/2 % of monthly sales. During the month he took off one day for vacation.
  • Since Knowit All is exempt and is paid by the salary method he receives the same for his regular earnings amount regardless of the number of hours worked and is not paid for any overtime.

Since monthly sales during the current month were $100,000 his bonus calculation is just a matter of multiplying the monthly sales times his bonus rate.
Bonus = Monthly Sales X Bonus Rate
Bonus = $100,000 X 1/2 %
Bonus = $500.00

  • So all we need to do is add his salary and bonus for the month in order to calculate his earnings - right ? Yes and no. Because as we stated earlier, Ma wants to keep up with how much holiday, sick time, and vacation time is costing her a year we have to make an additional calculation in order to assign pay to her manager's vacation time.

In order to do this, Ma only uses his regular salary (excludes bonus amounts) to calculate how much to allocate to his vacation time.
Ma converts his salary to an hourly rate by dividing his annual salary by the number of "normal" working hours in a year (2,080 hours).
Hourly Rate = $36,000 / 2,080 hours
Hourly Rate = $17.31

  • She then assigns a portion of his salary to vacation time by multiplying his calculated hourly rate times the number of hours of taken off for vacation.
    Vacation Time Pay = 8 hours X $17.31
    Vacation Time Pay = $138.48
  • Knowit All's regular earnings are then calculated by subtracting his vacation time pay from his normal salary for the month.
    Regular Earnings = Salary - Vacation Time Pay
    Regular Earnings = $3,000 - 138.48
    Regular Earnings = $2861.52
  • We're home free now. All we need to do is calculate his total earnings for the month.
    Total Earnings = Regular Earnings + Vacation Time Pay + Bonus
    Total Earnings = $ 2,861.52 + 138.48 + 500
    Total Earnings (Gross) = $3,500

(8) Betty Baker

  • Betty is paid by the piece rate method of pay. In other words, she is paid based on what she produces. The piece rate for her job is currently $1.00 for each desert prepared by her. Ma determined from Betty's daily production reports that Betty prepared 175 deserts during the current week.

If Betty's calculated earnings based on her production are less than what Betty would have earned based on minimum wage and her actual hours worked, Ma is required by law to pay her minimum wage.

  • Since Betty is nonexempt, Ma must also pay her for any overtime hours that she worked. Ma determined from Betty's time card that she worked 45 hours during the week so she is entitled to 5 hours of overtime pay.
  • Let's first calculate what Betty's Production Earnings are for the week.
    Production (Piece Rate) Earnings = Number Deserts Produced X Rate Per Desert
    Production Earnings = 175 pastries X $1.00
    Production Earnings = $175.00

Let's convert this to a rate per hour.
Production Straight Time Rate Per Hour = Production Earnings / Hours Worked
Production Straight Time Rate Per Hour = $175.00 / 45 hours
Production Straight Time Rate Per Hour = $3.89

  • Since Betty's calculated production rate per hour of $3.89 is less than the current minimum wage of $5.15 an hour, Ma must pay Betty the minimum wage for her actual hours worked.

Regular Earnings = Minimum Wage Per Hour X 40 hours
Regular Earnings = $5.15 X 40 hours
Regular Earnings = $206.00

  • In addition. since Betty worked 5 hours of overtime Ma must also pay her overtime based on minimum wage. Betty's overtime rate for the current week is 1.5 times the minimum wage ($5.15 X 1.5) or $7.73.

Overtime Earnings = Overtime Rate X Overtime Hours
Overtime Earnings = $7.73 X 5
Overtime Earnings = $38.65

  • Finally all we need to do is add Betty's regular and overtime earnings to calculate her total earnings for the week.
    Total Earnings = Regular Earnings + Overtime Earnings
    Total Earnings =$206.00 + 38.65
    Total Earnings = $244.65

(9) Line Man

  • Line Man is paid an hourly rate of $7.50 and Ma determined from checking his time card that he only worked 40 hours during the week .

Finally, we've got a payroll calculation we don't even need to think about. All we need to do is multiple his rate per hour times his hours worked which are all straight time (no overtime hours).

  • Regular and Total Earnings = Rate Per Hour X 40 hours
    Regular and Total Earnings = $7.50 X 40 hours
    Regular and Total Earnings = $300.00

(10) Talk Alot

  • Thank goodness our last employee. Talk Alot is our salesman in charge of banquets and special events. He is paid a 20 % commission of all banquet and special events sales. Banquet and special event sales totaled $1,000. He actually worked 40 hours during the week.
  • Let's dig in and see what his commission for the week amounts to.
    Commission = Commission Rate X Banquet & Special Event Sales
    Commission = 20% X $1,000
    Commission = $200.00

Are we finally done ? Well we know we don't have to pay him any overtime because he only worked 40 hours during the week. We do however have to make sure that he makes at least minimum wage for the actual hours that he worked. Remember the law states that regardless of how an employer calculates an employee's earnings, the employee must at least be paid minimum wage for the hours he/she worked.

  • OK , lets do a calculation similar to the calculation that we made with Betty Baker. First lets calculate his hourly rate based on his commission earnings.
    Commission Rate Per Hour = Commissions Earned / Actual Hours Worked
    Commission Rate Per Hour = $200.00 / 40 hours
    Commission Rate Per Hour = $5.00
  • Woops ! Since $5.00 an hour is less than the minimum wage of $5.15 we have to base Talk Alot's earnings on the current minimum wage rate and his actual hours worked.
    Regular Earnings = Minimum Wage X Regular Hours Worked
    Regular Earnings = $5.15 X 40 hours
    Regular Earnings = $206.00

What should you have picked up from following along with the different calculations used for determining our employees earnings ?

  • Tipped Employees are subject to special rules and laws.
  • All nonexempt employees must be paid overtime for all hours worked in excess of 40 hours during a week.
  • Only actual hours worked are used in calculating overtime.
  • We used the following methods of calculating our employee's earnings - hourly rate ,hourly rate + tips, piece rate, sales commission rate, salary for exempt, salary for nonexempt, and additional bonuses for some of our employees which illustrate that an employees earnings may be calculated using different agreed upon methods.
  • Although an employer and employee may agree on any method they want to calculate an employee's earnings, the employer must pay at least the minimum wage for the actual hours worked and must also pay overtime for any hours worked over 40 during a week for all nonexempt employees.
  • Bonuses, shift payments, and other compensation are normally included in calculating an employee's straight time and overtime rates.
  • We based our nonexempt salaried employees earnings on a 45 hour work week.

Regular Rate and Overtime Rate Calculation
The employee's rate calculation includes other compensation in addition to the employee's base rate of pay. The employee's actual calculated rate may vary week to week depending on what compensation they earned during the period.

Regular Rate and Overtime Rate Includes:

  • Base pay for all hours worked
  • Non discretionary bonuses
  • Fair market value of non cash compensation
  • Shift premiums
  • Production bonuses
  • Cost-of-living adjustments
  • Retroactive pay
  • All payments not specifically excluded by law

Regular Rate and Overtime Rate Excludes:

  • Reimbursed business expenses
  • Overtime in excess of FLSA requirement
  • Employer benefit plan contributions
  • Vacation/holiday/sick pay for unworked hours
  • Gifts on special occasions
  • Discretionary bonuses
  • Stock options

What was my purpose in using many different methods for calculating our employee's earnings ? To illustrate that calculating an employees earnings is not always just a simple exercise of multiplying hours times a rate.

Payroll Deductions

What the Employer "Giveth", The Government Taketh Away !

Finally, we're now done calculating our employee's gross pay (earnings), but we still have to calculate the deductions taken out from their pay. I guess there really is "no rest for the weary."

Employee Pay Period
W-4
Allowances
Total
Gross
Social
Security - (SS)
Medicare - (M)
Income
Tax
State
Tax
Medical Insurance
Pre Tax Deduction
Other Deductions
Savings - (S)
US Bonds - (B)
Tip Wages - (TW)
Walk Out - (WO)
Breakage - (BR)
Shortage - (CS)
Uniforms - (U)
(1) Fat Chef Bi-weekly
M-3
$1,461.10 84.39 - (SS)
19.74 - (M)
76.00
146.00
100.00 25.00 - (B)
25.00 - (U)
(2) Notbad Cook Bi-weekly
M-1
$888.95 48.91 - (SS)
11.44 - (M)
36.00
89.00
100.00 20.00 - (S)
(3) Goodwith Cash Weekly
M-2
$258.00 12.90 - (SS)
3.02 - (M)
0
26.00
50.00 25.00 - (CS)
(4) Wet Hands Weekly
M-1
$221.46 10.63 - (SS)
2.49 - (M)
0
22.00
50.00 15.00 -(BR)
(5) Good Waitress Weekly
M-1
$582.50 33.02 - (SS)
7.72 - (M)
34.00
58.00
50.00 25.00 - (WO)
250.00 - (TW)
(6) Handsome Waiter Weekly
M-2
$283.30 14.46 - (SS)
3.38 - (M)
0
28.00
50.00 50.00 - (WO)
50.00 - (TW)
(7) Knowit All Monthly
M-2
$3,500.00 203.55 - (SS)
47.60 - (M)
254.00
350.00
217.00 25.00 - (S)
25.00 - (B)
(8) Betty Baker Weekly
M-3
$244.65 12.07 - (SS)
2.82 - (M)
0
24.00
50.00  
(9) Line Man Weekly
M-1
$300.00 15.50 - (SS)
3.63 - (M)
4.00
30.00
50.00  
(10) Talk Alot Weekly
M-1
$206.00 9.67 - (SS)
2.26 - (M)
0
21.00
50.00  

Before we discuss our deductions, let's revisit Lesson 2 - Types Of Deductions. If you recall, we classified deductions into three categories:

  • Deductions Required by Law
  • Deductions for the Employer's Convenience
  • Deductions for the Employee's Convenience

Let's classify our deductions in our table above into our three categories.

  • Required By Law
  • Social Security
  • Medicare
  • Federal Income Tax
  • State Income Tax
  • Employer's Convenience
  • Uniforms
  • Breakage
  • Shortages
  • Walkouts
  • Tip Wages
  • Uniforms
  • Employee's Convenience
  • Medical Insurance
  • Savings
  • U. S. Bonds

Now we'll discuss the deductions taken out of each of Ma's employee's wages. Mom wants to be sure that she's following all the labor laws since she made some new rules about some of the deductions she takes (docks) from her employee's wages so she called in a hot shot accountant she heard about called Bean Counter (me) for his opinion and to determine if she needed to consult with an attorney or labor law specialist.

Dave Marshall (Bean Counter) looked over Ma's calculations and told Ma that she was doing a pretty good job of calculating her payroll but she might want to rethink some of her new rules concerning deductions for breakage, unpaid customer tabs, and cash shortages. Dave told Ma that although he's no expert in Labor Law that the law does not allow deductions that are classified as for the employer's convenience and that reduce an employee's wages below minimum wage. In effect, Ma's employees who are at all times considered as minimum wage employees include Handsome Waiter and Wet Hands and Ma would not be able to deduct such items as shortages, breakage, or unpaid customer tabs from their wages since the deduction would reduce their wages below minimum wage. In addition, Dave told Ma she could deduct this within limits for all her non-minimum wage employees but it didn't seem fair just making these type of deductions from her higher paid employees. Dave also told Ma that in the future, she might want to discuss any new policies with a Labor Law Professional prior to implementing them. Ma rescinded her new policies regarding these types of deductions. Ma said she would still monitor the shortages, breakage, and unpaid customer tabs and try to implement some better controls concerning customer unpaid tabs and would discuss breakage and cash shortages with her employees when warranted.

Mom revised her prior Payroll Worksheet and omitted any deductions for breakage, unpaid customer tabs, and cash shortages. Her revised Payroll Worksheet appears below.

Employee Pay Period
W-4
Allowances
Total
Gross
Social
Security - (SS)
Medicare - (M)
Income
Tax
State
Tax
Medical
Insurance
Other Deductions
Savings - (S)
US Bonds - (B)
Tip Wages - (TW)
Uniforms - (U)
Net Pay
(1) Fat Chef Bi-weekly
M-3
$1,461.10 84.39 - (SS)
19.74 - (M)
76.00
146.00
100.00 25.00 - (B)
25.00 - (U)
984.97
(2) Notbad Cook Bi-weekly
M-1
$888.95 48.91 - (SS)
11.44 - (M)
36.00
89.00
100.00 20.00 - (S) 583.60
(3) Goodwith Cash Weekly
M-2
$258.00 12.90 - (SS)
3.02 - (M)
0
26.00
50.00   166.08
(4) Wet Hands Weekly
M-1
$221.46 10.63 - (SS)
2.49 - (M)
0
22.00
50.00   136.34
(5) Good Waitress Weekly
M-1
$582.50 33.02 - (SS)
7.72 - (M)
34.00
58.00
50.00 250.00 - (TW) 149.76
(6) Handsome Waiter Weekly
M-2
$283.30 14.46 - (SS)
3.38 - (M)
0
28.00
50.00 50.00 - (TW) 137.46
(7) Knowit All Monthly
M-2
$3,500.00 203.55 - (SS)
47.60 - (M)
254.00
350.00
217.00 25.00 - (S)
25.00 - (B)
2377.85
(8) Betty Baker Weekly
M-3
$244.65 12.07 - (SS)
2.82 - (M)
0
24.00
50.00   155.76
(9) Line Man Weekly
M-1
$300.00 15.50 - (SS)
3.63 - (M)
4.00
30.00
50.00   196.87
(10) Talk Alot Weekly
M-1
$206.00 9.67 - (SS)
2.26 - (M)
0
21.00
50.00   123.07

Now we'll take a look at how to calculate or determine the deductions taken out of an employee's pay.

Social Security & Medicare

The calculation of the deductions for social security and medicare is straight forward. All we need to do is multiply the wages subject to social security and medicare by the current rates. Wages subject to social security and medicare are total earnings less any "special" pre tax deductions. The current rate for social security is 6.2 % or .062 and for medicare the current rate is 1.45 % or .0145.

There is a maximum amount that may be withheld during a calendar year for social security. The maximum deduction amount for the year 2004 is/was $5449.80. This is based on the maximum earnings amount of $87,900. All employee earnings over $87,900 are excluded from additional withholdings. There is no maximum for medicare thus all wages earned during the year are subject to the medicare "tax".

As stated earlier all we need to do in order to calculate the deductions for social security and medicare is to multiply an employee's earnings less any pre tax deductions allowed times the appropriate rates. Additionally, for our higher paid employees we need to make sure that their earnings have not exceeded the maximum salary base.

Let's do our math ! We'll start with our chef.

Fat Chef

  • Social Security Deduction = (Earnings - Medical Insurance) X Social Security Rate
    Social Security Deduction = ($1,461.10 - 100.00) X .062
    Social Security Deduction = $84.39
  • Medicare Deduction = (Earnings - Medical Insurance) X Medicare Rate
    Medicare Deduction = ($1,461.10 - 100.00) X .0145
    Medicare Deduction = $19.74

Why did we deduct medical insurance from the earnings before we calculated the social security and medicare deductions ? If you recall, one of our assumptions about Ma's restaurant was that Ma pays 50% of a family's premium for health insurance and her medical plan qualifies with the IRS for tax-exempt treatment. This deduction for the employee's share of the medical insurance premium thus qualifies for special tax treatment.

This special type of deduction is called a pre tax deduction. Pre tax deductions (benefits) are those benefits deducted from an employee's wages (gross pay) before taxes come out. The medical insurance deduction in our example is made on a pre tax basis, thereby reducing the our calculated amounts deducted for social security, medicare, and federal and state income taxes.

What's so special ?
By deducting these special types of deductions before we calculate the payroll taxes and income tax withholdings, the employee has more take home pay ( a bigger net pay check). The employer also saves on their social security and medicare matching contributions. This also provides a savings to employers for unemployment taxes.

Let's calculate Fat Chef's social and security without considering the special tax treatment and see what he saves and Ma as the employer also saves in payroll taxes.

  • Social Security Deduction = Earnings X Social Security Rate
    Social Security Deduction = $1,461.10 X .062
    Social Security Deduction = $90.59
  • Medicare Deduction = Earnings X Medicare Rate
    Medicare Deduction = $1,461.10 X .0145
    Medicare Deduction = $21.19
  Pre Tax After Tax Savings
Social Security 84.39 90.59 6.20
Medicare 19.74 21.19 1.45
       
Totals 104.13 111.78 7.65

If I did my math correctly, it looks to me as if Fat Chef and Ma both saved a total of $7.65.

Before you say oh wow, remember this is the savings on only one pay check. Fat Chef gets paid every two weeks, so if we assume he earns the same amount for each pay period, the saving for the entire year are $198.90 (26 pay periods X $7.65). Remember Ma also gets to save this amount. I don't know about you, but I'd gladly take approximately an extra $200.00 a year home in my pay check.

Some examples of pre tax benefits that are offered by employers are:

  • health and dental insurance premiums
  • employee retirement plans such as 401k contributions
  • group term life insurance
  • dependent care programs
  • medical reimbursement accounts
  • disability benefits

Since these calculations are basically just a mathematical exercise, I'm going to illustrate the rest of our employee social security and medicare deductions using a simple table. If you've got the urge, get out your calculator and check me out. Notice that we reduced the earnings by the employee's share of the medical insurance in all our calculations.

Employee (Gross Earnings - Medical Insurance) X Social Security Rate Social Security Deduction (Gross Earnings - Medical Insurance) X Medicare Rate Medicare Deduction
Notbad Cook ($888.95 - 100.00) X .062 = $48.91 ($888.95 - 100.00) X .0145 = $11.44
Goodwith Cash ($258.00 - 50.00) X .062 = $12.90 ($258.00 -50.00) X .0145 = $3.02
Notbad Cook ($888.95 - 100.00) X .062 = $48.91 ($888.95 - 100.00) X .0145 = $11.44
Wet Hands ($221.46 - 50.00) X .062 = $10.63 ($221.46 - 50.00) X .0145 = $2.49
Good Waitress ($582.50 - 50.00) X .062 = $33.02 ($582.50 - 50.00) X .0145 = $7.72
Handsome Waiter ($283.30 - 50.00) X .062 = $14.46 ($283.30 - 50.00) X .0145 = $3.38
Knowit All ($3,500.00 - 217.00) X .062 = $203.55 ($3,500.00 - 217.00) X .0145 = $47.60
Betty Baker ($244.65 - 50.00) X .062 = 12.07 ($244.65 - 50.00) X .0145 = $2.82
Line Man ($300.00 - 50.00) X .062 = $15.50 ($300.00 - 50.00) X .0145 = $3.63
Talk Alot ($206.00 - 50.00) X .062 = $9.67 ($206.00 - 50.00) X .0145 = $2.26

Income Tax Withholdings (deductions)

Next we'll take a look at how we determine how much to withhold from our employee's earnings for income tax. The purpose of withholding income taxes is to take deductions from his/her earnings that will approximate the employee's actual year end income tax liability. The amount to withhold is determined for each employee.
What factors determine the amount to withhold ?

  • How often an employee is paid -the frequency of payroll periods.
  • Employee's marital status.
  • Number of withholding exemptions the employee claims on his/her W-4 Form.
  • Amount of the employee's earnings.
  • Any Pre Tax Deductions

In order to make it easy for employer's to determine how much to withhold, the IRS has incorporated the above factors into easy to use tables. The tables are found in IRS Publication 15, Circular E.

There are two basic frequently used types of withholding tables:

  • Wage Bracket Tables
    This is the easiest table used to determine how much to withhold from an employee's wages and saves the employer from having to make additional calculations prior to using the tables.

Tables are provided for five different types of payroll periods (weekly, biweekly, semimonthly, monthly, and daily/miscellaneous) and the marital status of Single/Head of Household or Married.
Note: No tables are supplied for quarterly, semiannually, and annually pay periods. If you pay using these pay periods you need to use the percentage method tables.

All you need to do to properly use the tables are:

  • Determine the employee's frequency of payment (payroll period).
  • Obtain the employee's Marital Status from W-4 .
  • Based on the payroll period and marital status select the appropriate percentage withholding table.
  • Using the employee's earnings for the pay period find the row containing the wage bracket within which the wages fall.
  • Using the employee's withholding allowances obtained from their W-4 read across the wage bracket line to the table column that has the number of withholding allowances claimed by the employee where the amount to withhold is given.
  • Percentage Method Tables
    Percentage method tables are available for eight different payroll periods (weekly, biweekly, semimonthly, monthly, quarterly, semiannual, annual, and daily/miscellaneous), and there are separate sets of tables for married and single/head of household employees.

To properly use the tables you need to do the following:

  • Determine the employee's frequency of payment (payroll period).
  • Obtain the employee's Marital Status from W-4 .
  • Adjust (reduce) the employee's wages by the value of the employee's withholding allowance obtained from the withholding allowance table multiplied by the number of exemptions claimed on his/her W-4.
  • Based on the payroll period and marital status select the appropriate percentage withholding table.
  • Find the wage bracket within which the employee's adjusted wages (earnings reduced by value of employee's withholding allowances) fall.
  • The amount to withhold is shown in the table as a dollar amount plus a percentage of that portion of the wages that exceeds the minimum bracket amount.

Unlike our earlier table, we have to do a little calculating based on the information in the table in order to determine the amount to withhold.

  • Step (1) We have to subtract the minimum bracket amount from our adjusted earnings.
  • Step(2) Using the amount we calculated in Step (1) , we need to multiply this amount by the percentage amount found in the table.
  • Step(3) We need to add the dollar amount found in the table and our calculated amount determined in Step (2) to finally arrive at the amount to withhold.

There are other methods that you can use to determine how much you must withhold. The two methods we discussed are probably two of the most commonly used. See IRS Publication 15, Circular E for more information.

Ma's like many of us and wants to use the easiest and quickest method for calculating the amount of income tax to withhold from her employee's so she chooses the wage bracket tables method because she doesn't have to make additional calculations.

All you have to do to find the amount of income tax to withhold from an employee's wages using the table is:

  • Know the employee's pay period.
  • Know the employee's marital status.
  • Know the number of withholding allowances on the employee's W-4 form.
  • Find the row that has the wage bracket where the employee's gross earnings fall within and the column that has the number of allowances claimed and use the amount given as the employee's withholding amount.

Ma's pays some of her employees weekly, biweekly, and monthly and all her employees are married. We thus only need to use the tax tables for married-weekly, married-biweekly, and married-monthly employees in order to calculate her employee's income tax withholdings.

Let's organize the employee information the way we need it to easily use the tables. Since the tables are by pay period let's group our employee information by pay period - in other words by how often they're paid.

Remember our prior discussion about pre tax deductions and how they affected Ma's social security and medicare deductions ? Well, they also provide an income tax saving to Ma's employees. This saving is reflected in the amount of income tax taken from an employee's pay check. Hooray - more take home pay again !

In the table below, take notice of how the earnings were reduced by the pre tax medical insurance premium before the amount of income tax withheld was calculated.

Weekly Pay Period Employees

Name Marital Status
& Exemptions
Wages Pre Tax Medical Deduction Taxable Wages
Goodwith Cash M-2 $258.00 $50.00 $208.00
Wet Hands M-1 $221.46 $50.00 $171.46
Good Waitress M-1 $582.50 $50.00 $532.50
Handsome Waiter M-2 $283.30 $50.00 $233.30
Betty Baker M-3 $244.65 $50.00 $194.65
Line Man M-1 $300.00 $50.00 $250.00
Talk Alot M-1 $206.00 $50.00 $156.00

Biweekly Pay Period

Name Marital Status
& Exemptions
Wages Pre Tax Medical Deduction Taxable Wages
Fat Chef M-3 $1,461.10 $100.00 $1361.10
Notbad Cook M-1 $888.95 $100.00 $788.95

Monthly Pay Period

Name Marital Status
& Exemptions
Wages Pre Tax Medical Deduction Taxable Wages
Knowit All M-2 $3,500.00 $217.00 $3283.00

How much in income tax do Ma's employees save because of the pre tax medical insurance deduction ? It actually depends on each of her employees tax bracket. Just for illustration purposes, let's assume an average tax bracket of 15 % for all of Ma's employees. If you recall from earlier, the total medical insurance premium is $5,200 and Ma pays half ( 50 % ). Thus the employee's share is $2,600 a year (50% X 5,200).

Ma's Employees Estimated Tax Savings:

  • Total Employee Deductions for Medical Insurance = Number of Employees X 2,600
    Total Employee Deductions for Medical Insurance = 10 X 2,600
    Total Employee Deductions for Medical Insurance = 26,000
  • Estimated Income Tax Savings = Estimated Tax Rate X Total Employee Deductions for Medical Insurance
    Estimated Income Tax Savings = 15 % X 26,000
    Estimated Income Tax Savings = $3,900

Wage Bracket Tables

The following portions of the tables were taken from IRS Publication 15. Three tables are needed for Ma's business because she pays some employees weekly, biweekly, and monthly and all are married. If she had any single employees she would also need to consult the IRS tables provided for single employees. If you need or want to check out the complete tables download Publication 15 from the IRS site. The Rows in the tables contain the Wage Brackets (ranges) and the Amount to Withhold and the Columns contain the Number Of Exemptions.

Since we have all the information we need to properly use the tables, our task of finding the amount to withhold from our employee's is simply (1) selecting the proper Pay Period Table and (2) using our employee's Actual Taxable Wages to find the appropriate Row (Wage Bracket) and then (3) reading the Amount To Withhold from the Column that contains the Number of Employee Withholdings.

To illustrate where the withholding amounts came from, I've made simple tables that includes the employee's name and earnings that follow the IRS's actual tables - weekly - biweekly - monthly below so that you can easily determine and see where the amount to withhold came from in the actual IRS tables.


Married Weekly

Employee Actual Taxable Wages If wages are And the number of withholding allowances claimed is
  At least But less than 0 1 2 3
    The amount of income tax to be withheld is
Goodwith Cash $208.00 200 210 5 0 0 0
Wet Hands $171.46 170 175 2 0 0 0
Good Waitress $532.50 530 540 43 34 26 20
Handsome Waiter $233.30 230 240 8 2 0 0
Betty Baker $194.65 190 195 4 0 0 0
Line Man $250.00 250 260 10 4 0 0
Talk Alot $156.00 155 160 0 0 0 0

Nothing to it - right ? All we did is find the row in the table that the employee's wages fell within and the column for the number of allowances claimed by the employee on their W-4.


Married Biweekly

Employee Actual Taxable Wages If wages are And the number of withholding allowances claimed is
  At least But less than 0 1 2 3
    The amount of income tax to be withheld is
Fat Chef $1,361.10 1,360 1,380 131 113 94 76
Notbad Cook $788.95 780 800 48 36 24 11

Same ole same ole. All we did is use the Married - Biweekly table for our employee's paid every two weeks to find the row in the table that the employee's wages fell within and the column for the number of allowances claimed by the employee on their W-4.

Married Monthly

Employee Actual Taxable Wages If wages are And the number of withholding allowances claimed is
  At least But less than 0 1 2 3
    The amount of income tax to be withheld is
Knowit All $3,283.00 3,280 3,320 334 294 254 214

One again, all we did is use the Married - Monthly table for our employee's paid every month to find the row in the table that the employee's wages fell within and the column for the number of allowances claimed by the employee on their W-4.

What should you gather from our review of the Wage Bracket Method of calculating the amount of income tax to withhold ?

  • The more exemptions an employee claims on their W-4 the less the amount of taxes withheld.
  • Vice versa. The less exemptions an employee claims on their W-4 the greater the amount of taxes withheld.
  • No special calculations are needed to determine the amount to withhold.
  • Tables are provided for married and single employees.
  • Tables are provided for the frequency of payment (how often an employee is paid) such as weekly, semiweekly, or monthly.

Percentage Method Of Withholding
You didn't think I was going to let the other common method slide by without at least showing you an example or two of how to calculate the amount of income tax to withhold did ya ?

As we earlier stated, to properly use the percentage tables you need to do the following:

  • Determine the employee's frequency of payment (payroll period).
  • Obtain the employee's Marital Status from W-4 .
  • Adjust (reduce) the employee's wages by the value of the employee's withholding allowance obtained from the withholding allowance table multiplied by the number of exemptions claimed on his/her W-4.
  • Based on the payroll period and marital status select the appropriate percentage withholding table.
  • Find the wage bracket within which the employee's adjusted wages (earnings reduced by value of employee's withholding allowances) fall.
  • The amount to withhold is shown in the table as a dollar amount plus a percentage of that portion of the wages that exceeds the minimum bracket amount.

We have to do a little calculating based on the information in the table in order to determine the amount to withhold.

  • Step (1) We have to subtract the minimum bracket amount from our adjusted earnings.
  • Step(2) Using the amount we calculated in Step (1) , we need to multiply this amount by the percentage amount found in the table.
  • Step(3) We need to add the dollar amount found in the table and our calculated amount determined in Step (2) to finally arrive at the amount to withhold.

Withholding Allowance Table

Pay Period One Withholding Allowance
Weekly 61.54
Bi-weekly 123.08
Semimonthly 133.33
Monthly 266.67
Quarterly 800.00
Semiannually 1,600.00
Annually 3,200.00
Daily 12.31

The annual amount of $3,200 is used to convert the amount allowed for the other pay periods. The amounts used in the above table are based on the following calculations:

Weekly - 3,200 / 52 pay periods = 61.54
Bi-weekly - 3,200 / 26 pay periods = 123.08
Semimonthly - 3,200 / 24 pay periods = 133.33
Monthly - 3,200 / 12 pay periods = 266.67
Quarterly - 3,200 / 4 pay periods = 800.00
Semiannually - 3,200 / 2 = 1,600.00
Annually - 3,200
Daily = 3,200 /260 (working days in year) = 12.31

Percentage Method Withholding Tables

All the tables that are needed for the percentage method of withholding like the wage bracket tables are contained in IRS Publication 15 - Circular E. The Weekly , Biweekly, and Monthly tables are illustrated below. Our examples will only be using the Weekly Table; however, the calculations used with the different Pay Period Tables all follow the same logic and steps.


We'll use two of our weekly paid employees Good Waitress and Line Man and our monthly paid employee Knowit All for our examples.

We use the following steps to determine our employee's withholdings using the percentage withholding method:

  • Determine the employee's frequency of payment (payroll period).
  • Obtain the employee's Marital Status from W-4 .
  • Adjust (reduce) the employee's wages by the value of the employee's withholding allowance obtained from the withholding allowance table multiplied by the number of exemptions claimed on his/her W-4.
  • Based on the payroll period and marital status select the appropriate percentage withholding table.
  • Find the wage bracket within which the employee's adjusted wages (earnings reduced by value of employee's withholding allowances) fall.
  • The amount to withhold is shown in the table as a dollar amount plus a percentage of that portion of the wages that exceeds the minimum bracket amount.

We have to do a little calculating based on the information in the table in order to determine the amount to withhold.

  • Step (1) We have to subtract the minimum bracket amount from our adjusted earnings.
  • Step(2) Using the amount we calculated in Step (1) , we need to multiply this amount by the percentage amount found in the table.
  • Step(3) We need to add the dollar amount found in the table and our calculated amount determined in Step (2) to finally arrive at the amount to withhold.

Let's gather the information we need for our three sample employees. We need their pay period, number of exemptions claimed, and taxable earnings.

Employee Pay Period
W-4 Allowances
Claimed
Earnings Calculated
Exemption Amount
Adjusted
Earnings
Good Waitress Weekly
M-1
$532.50 $61.54 X 1 = $61.54 $470.96
Line Man Weekly
M-1
$250.00 $61.54 X 1 = $61.54 $188.46
Knowit All Monthly
M-2
$3,283.00 $266.67 X 2 = $533.34 $2,749.66

We calculated the deduction for their exemptions by obtaining the amount allowed for one exemption from our exemption table based on the employee's pay period and multiplying this amount times the number of allowances claimed on their W-4. The amount for our weekly paid employees was $61.54 and $266.67 for our monthly paid employee.

Now we need to select the appropriate percentage withholding table based on the employee's payroll period and marital status. Our three example employees are all married and two are paid weekly and one is paid monthly.
We need to use two percentage withholding tables:

  • Married - Weekly
  • Married - Monthly

Then, we need to find the wage bracket within which the employee's adjusted wages (earnings reduced by value of employee's withholding allowances) fall and obtain the information needed to calculate the amount to withhold. remember, the amount to withhold is shown in the table as a dollar amount plus a percentage of that portion of the wages that exceeds the minimum bracket amount.

Table 1 Weekly Pay Period - Married

Employee Adjusted Earnings If the amount of wages ( after subtracting withholding allowances ) is : The amount of income tax to withhold is :
  Over But Not Over   of excess over
Good Waitress $470.96 $435 $1273 $28.10 plus 15% $435
Line Man $188.46 $154 $435 10% $154

At last our final steps.

  • Step (1) We have to subtract the minimum bracket amount from our adjusted earnings.
  • Step(2) Using the amount we calculated in Step (1) , we need to multiply this amount by the percentage amount found in the table.
  • Step(3) We need to add the dollar amount found in the table and our calculated amount determined in Step (2) to finally arrive at the amount to withhold.

Good Waitress Calculation
Good Waitress amounts from the table are $28.10 plus 15 % of excess over $435.
Excess Over $435 = $470.96 - 435.00
Excess Over $435 = $35.96
15 % of Excess = .15 X $35.96
15 % of Excess = $5.39
Total Withholding Amount = $28.10 + $5.39
Total Withholding Amount = $33.49

Line Man
Line Man amounts from the table are $0 plus 10 % of excess over $154.
Excess Over $154 = $188.46 - 154.00
Excess Over $188 = $34.46
10 % of Excess = .10 X $34.46
10 % of Excess = $3.45
Total Withholding Amount = $3.45

Table 4 Monthly Pay Period - Married

Employee Adjusted Earnings If the amount of wages ( after subtracting withholding allowances ) is : The amount of income tax to withhold is :
  Over But Not Over   of excess over
Knowit All $2,749.66 $1,883 $5,517 $121.60 plus 15% $1,883

Knowit All Calculation
Knowit All amounts from the table are $121.60 plus 15 % of excess over $1,883.
Excess Over $1,883 = $2,749.66 - 1,883.00
Excess Over $1,883 = $866.66
15 % of Excess = .15 X $866.66
15 % of Excess = $130.00
Total Withholding Amount = $121.60 + $130.00
Total Withholding Amount = $251.60

Before we move on, let's compare the results obtained from using the Percentage and Wage Bracket Methods of calculating income tax withholdings.

Employee Wage Bracket
Method
Percentage
Method
Good Waitress $34.00 $33.49
Line Man $4.00 $3.45
Knowit All $254.00 $251.60

Not much difference is there?

Note: The Annual Percentage Withholding Table is the table used by many payroll computer software programs and when the IRS revises the tables the user many times have to pay what I consider an outrageous fee to update their software to the new current table. As you can see, there's really not much involved in updating the table. The reason the annual table is used is that the annual table can easily be converted into a table for any payroll period - weekly, biweekly, etc. by performing some simple mathematical calculations.

All that is required, is to figure the amount of income tax to withhold based on annual wages and prorate the tax calculated based on the employee's actual pay period.

Example:
A married person claims two withholding allowances and is paid $500 for the week. Multiply the weekly wages of $500 by 52 weeks to convert the weekly wage into an annual wage of $26,000. Subtract $6,400 ($3,200 X 2) the annual value of 2 withholding allowances for 2005 to arrive at a balance of $19,600. Using the table for the annual period, divide the annual amount calculated by 52 to arrive at the weekly pay period amount to withhold.
Using the Annual Table, the calculated amount of $19,600 falls in the range of over $8,000 but not over $22,600.

Annual Amount Calculated = 10 % of excess over $8,000.
Annual Amount Calculated = ($19,600 - $8,000) X 10%.
Annual Amount Calculated = $1,160

Convert Annual Amount To Weekly Amount
Weekly Amount To Withhold = Annual Amount Calculated / 52 weeks
Weekly Amount To Withhold = $1,160 / 52 weeks
Weekly Amount To Withhold = $22.31

The same logic may be used to calculate the amount to withhold for any pay period - biweekly, monthly, etc. This is the reason it's used by many payroll computer software programs.

State Income Tax
In our example calculations, we used a flat 10% rate. In the real world, the states have tables that are similar to the tables provided by the IRS. You need to consult your state agency to find out what the requirements are for your state(s). The following is a listing of sites provided to aid you in determining what are the requirements for your state.

  • Find Your State
    These links guide you to your state's labor laws.
  • State Withholding Information
    http://www.taxsites.com/state.html
    Taxsites.com has provided an easy to use Tax and Accounting Sites Directory .
  • State Income Tax Withholding
    http://www.toolkit.cch.com/text/P07_1278.as
    CCH also has provided a nice State Income Tax Withholding Map that guides you to the state information you may need.

Additional Withholdings
Employees may request that a fixed amount of federal and/or state income tax be withheld in addition to their regular withholding. This fixed federal or state tax deduction may be for any amount and may be discontinued at any time by completing a new W-4.

Other Deductions

The other deductions such as medical insurance, savings bonds, uniforms, etc. are deductions that the employee has authorized Ma to deduct from their wages. Note: Since tips paid by customers are required to be reported and included in a tipped employee's wages, the employer must also show them as a deduction or offset to earnings since tips are not paid by the employer but by the customer.

Deductions - what order are payroll deductions deducted from an Employee's pay?
Payroll deductions are usually taken in a priority order: FICA, Federal Taxes, State Taxes, conditions of employment deductions such as retirement, mandated deductions, health insurance deductions and voluntary deductions. If, for some reason, the Employee's paycheck does not have enough funds to cover the entire amount of any deduction, then that deduction is not taken and is usually handled by setting up an employee receivable or arrears account in order to deduct the amount in a future payroll period.

For Your Information

  • Additional Withholding Methods
    Besides the two methods that we used for calculating the amounts of social security, medicare, and income tax deductions, the IRS also has some additional optional methods. For additional information about these methods, consult IRS Publication 15-A, Employer's Supplemental Tax Guide.
  • Advance Earned Income Credit Payments
    None of our example employees were illustrated receiving advanced earned income credit payments. Although I did not provide an example, you as an employer do need to be aware that you may have to make these payments to some of your employees.

The purpose of this employee payroll option is to make advance payments to employees who qualify for taking the earned income credit on their personal tax returns. Basically, the credit is designed to provide lower wage earners with children a tax break.

Most of the smaller companies I've worked with have not had their employees take advantage of this early payment of the credit option. In my opinion, the reason is because it requires the employer to make some additional calculations and many employees don't know about it.

In order for an employee to receive Advance Earned Income Payments they must qualify and submit Form W-5.

The amount of the advance payment an employee receives is based on tables similar to the tables we used to determine the amount of income tax to withhold.

Additional information and the tables are included in IRS Publication 15, Circular E.

  • Pre tax Deductions
    Note to the wise, not all pre tax deductions are handled the same as our medical insurance deduction. For example, pre tax deductions for an approved employee retirement plan such as a 401 K is subject to social security and medicare taxes but not subject to income tax withholding.

What should you have picked up from following along with our deduction calculations ?

  • Discussed and determined that some deductions might require you to seek professional help and guidance.
  • Learned that some deductions called pre tax receive favorable tax treatment
  • IRS publications provide employers with tables and methods to aid in calculating social security, medicare, and amounts of income tax to withhold from employee's salaries and wages.
  • Most states have a state income tax and require employers to withhold (deduct) estimated amounts for state employee income tax. The states provide tables and methods similar to the IRS tables and methods for calculating the amounts.
What About Ma ?
Since Ma is the owner of a sole proprietorship, Ma is not officially classified as an employee and is not included in the regular payroll. When Ma needs money to pay personal bills she receives what is called a draw and is subject to some special rules and laws which we will discuss in Lesson 6 - Self Employed.

I don't know if you were aware, but by using our fictitious business Ma's Secret Recipes we covered quite a bit of material. What all did we cover ?

  • Classified employees as exempt or nonexempt.
  • Illustrated Different Methods used to compute wages and salaries.
  • Provided Job Categories to our employees.
  • Used different Pay Periods.
  • Performed Overtime Calculations.
  • Learned a little about Tips.
  • Calculated Required Government Deductions and used approved methods and tables for calculating the amount of employee income tax withheld.
  • Learned that some deductions called pre tax receive favorable tax treatment.
  • Discussed and determined that some deductions might require you to seek professional help and guidance.
  • IRS publications provide employers with tables and methods to aid in calculating social security, medicare, and amounts of income tax to withhold from employee's salaries and wages.
  • Most states have a state income tax and require employers to withhold (deduct) estimated amounts for state employee income tax. The states provide tables and methods similar to the IRS tables and methods for calculating the amounts.

I don't know about you but I'm worn out doing all these calculations. I sure don't want you having to run to keep up ! You probably deserve a break - why not relax a little and dig into the remaining lessons later ?

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