How Employers Calculate Payroll

Payroll is calculated in a set order: figure gross pay, subtract pre-tax deductions, calculate and withhold taxes, subtract after-tax deductions, and pay what's left as net pay. The employer then adds its own payroll taxes on top and sends the withheld money to the IRS and state agencies.

If you've ever wondered how payroll is calculated behind your pay stub, this walk-through follows one paycheck from timesheet to direct deposit. Knowing the order makes it much easier to check your own stub.

Step 1: Gather Employee Information

Before the first paycheck, an employer collects what it needs to calculate pay correctly:

Form W-4 for federal income tax withholding, which reports filing status, multiple jobs, dependents and other adjustments. Our W-4 form explained guide covers each step.
A state withholding form, where the state has its own.
Pay rate and classification: hourly or salaried, and exempt or non-exempt from overtime under the Fair Labor Standards Act.
Benefit elections such as 401(k) percentage, health plan and HSA contributions.
Work and home locations, which determine which state and local taxes apply.

Step 2: Calculate Gross Pay

Gross pay is everything earned in the pay period before any deductions. For salaried employees, it's usually annual salary divided by the number of pay periods. For hourly employees, it's hours worked times the hourly rate, plus overtime.

Federal law requires at least 1.5 times the regular rate for hours over 40 in a workweek for non-exempt employees. Overtime is calculated week by week, even on a biweekly schedule. Bonuses, commissions, shift differentials and tips are also added to gross pay. See how overtime pay is calculated for the details, including how bonuses can change the regular rate.

Step 3: Subtract Pre-Tax Deductions

Next, payroll subtracts deductions that reduce taxable wages. Not all of them reduce the same taxes:

Deduction	Reduces federal income tax?	Reduces Social Security and Medicare?
Traditional 401(k), 403(b), 457	Yes	No
Health, dental, vision premiums (cafeteria plan)	Yes	Yes
HSA contributions through payroll	Yes	Yes
Roth 401(k)	No	No

This is why your stub may show different "taxable wages" figures for federal income tax and for Social Security and Medicare.

Step 4: Calculate Taxes and Withholding

Federal income tax

Employers use the IRS methods in Publication 15-T. The common approach annualizes your taxable pay for the period, applies the W-4 adjustments and the yearly tax brackets, then divides back down to one pay period. For 2026, the standard deduction built into this is $16,100 for single filers and $32,200 for married filing jointly.

FICA taxes

Social Security is 6.2% of wages up to $184,500 for 2026, and Medicare is 1.45% with no cap. Employers also withhold an extra 0.9% Additional Medicare Tax on wages over $200,000 in a year.

State and local taxes

Most states have their own withholding formulas, and some cities, counties and school districts add local income taxes. Nine states have no wage income tax. A few states also have employee-paid payroll items, such as Washington's WA Cares Fund at 0.58% of wages (see the Washington paycheck calculator).

Step 5: Subtract After-Tax Deductions and Pay Net

After taxes, payroll subtracts after-tax items such as Roth 401(k) contributions, supplemental life insurance, union dues, charitable giving and any garnishments. What remains is net pay, delivered by direct deposit, check or pay card. Our guide to gross pay vs. net pay explains the gap between the two.

Worked Example: An Hourly Paycheck With Overtime

Here's how payroll is calculated for a single filer in Minnesota earning $22 an hour, paid biweekly, who worked 45 hours in each week of the pay period. They contribute 4% to a traditional 401(k) and pay $40 per paycheck in pre-tax health premiums.

Regular pay: 80 hours × $22 = $1,760.00.
Overtime pay: 5 hours over 40 in each week = 10 hours × $33 (1.5 × $22) = $330.00.
Gross pay: $2,090.00.
Pre-tax deductions: 401(k) at 4% = $83.60; health premium = $40.00.
Taxes: federal income tax $152.12, Social Security $127.10, Medicare $29.73, Minnesota income tax $75.12.
Net pay: $1,582.33.

These are estimates from our paycheck calculator. In a pay period without overtime (80 hours), the same worker's estimated net pay would be $1,347.14, so the 10 overtime hours add $235.19 in take-home pay. You can test other hours in the Minnesota paycheck calculator, and our calculation methodology page explains how the estimates are built.

Step 6: Employer Taxes and Filings

Your paycheck is only part of what payroll costs. Employers also pay taxes that never appear as deductions on your stub:

Employer Social Security and Medicare: a matching 6.2% and 1.45%. For the Minnesota worker, that match is $156.83 for the pay period, equal to the employee's own $127.10 plus $29.73.
Federal unemployment tax (FUTA) and state unemployment tax (SUTA): paid by the employer in most states, with rates and wage bases that vary. A few states also charge employees a small unemployment amount; Pennsylvania withholds 0.07% from employee wages.
Other state programs, such as workers' compensation, which varies by state and industry.

Employers then deposit withheld income tax and both halves of FICA with the IRS on a set schedule, file quarterly returns such as Form 941, and send each employee a W-2 after the year ends.

Frequently Asked Questions

How is payroll calculated for salaried employees?

Annual salary is divided by the number of pay periods to get gross pay. The same deduction and tax steps then apply as for hourly workers.

Why doesn't my federal withholding match the tax brackets?

Withholding annualizes one paycheck and applies the standard deduction and brackets, so only part of your pay falls in your top bracket. See the IRS Publication 15-T methods for the exact formulas.

Do employers pay part of my taxes?

Employers pay a matching share of Social Security and Medicare plus unemployment taxes. Your income tax is yours; the employer only withholds and forwards it.

What happens if my employer calculates payroll wrong?

Mistakes are usually fixed on a later paycheck or with an adjustment. Report errors to payroll in writing and keep your pay stubs.

Sources

Run the numbers for your state

PaycheckHubs Editorial Team

Written and checked against IRS, Social Security Administration and state tax agency publications for the 2026 tax year. General information, not tax, legal or financial advice. Read our editorial policy, calculation methodology and sources.