How To Pay Yourself As a Small Business Owner

Today I'm going to talk about how to calculate employee checks, step-by-step so you'll know how to do it. Okay, let's start from the top. This is called the paycheck formula. The paycheck formula goes like this: We're going to start with taxable wages, which is also referred to as gross pay, minus pre-tax deductions, minus employee taxes, minus after-tax deductions, plus non-taxable reimbursements. This will equal your net pay. 

Net Pay = Gross Pay - Pre tax deductions - Employee Taxes - After tax Deductions + Non Taxable Reimbursement

Before you put the paycheck formula into practice let's talk about the ingredients you will need to manually calculate a paycheck. For that, you're gonna need the following items to calculate the paycheck manually:

  • the employee's hourly rate or salary

  •  federal, state, and local tax rates 

  • information about the employee's retirement contributions

  •  deductions, and reimbursements. 

Now let's go into the details for calculating an employee's paycheck. It involves five steps and I'll walk you through each one.

Step Number One

we're going to calculate our employee's gross wages. Gross wages are the full amount an employer pays before deductions are made. Gross wages can sometimes exceed regular wages. For example, if they include overtime pay or bonuses. All of these wages are generally subject to tax. The components that go into calculating gross wages, include an employee's hourly rate, or a salary rate, how frequently you pay them, and whether another aspect of their compensation, such as bonuses, are paid on an annual basis or even in each period. If the employee has worked overtime, that needs to be calculated at the appropriate rate as well. Overtime rates vary by state.

Step Number Two

Is to take out any elective pre-tax items. These items, the employee has chosen to withhold from their paychecks. This includes things like health insurance and employee 401K contributions. All of these pre-tax items essentially reduce the employee's taxable wages.

Step Number Three

Which is to deduct employee taxes. this includes your employee’s federal income taxes, as well as taxes owed to the state, city, or local governments. I'm also adding a special half-step. Let's call it " step three and a half,'' which is to accrue The employer portion of FICA, which is the tax used to fund social security and Medicare. These taxes are paid 50% by the employer.

Step Number Four

Is to take out any involuntary deductions from the employee's paycheck. A wage garnishment is a good example of an involuntary deduction. It may be a required payment to repay debts such as child support. Typically the business will receive formal instructions from the court, including the amounts and the frequency.

Step Number Five 

Is to add all non-taxable reimbursements to the net of the employee's paycheck. This is when the employers pay back employees when they spend their own money on business-related expenses, such as travel, or purchases for work-related supplies and tools.

These are called non-taxable reimbursements because they typically don't count towards calculating taxable wages but they do increase the net check. All these items will help you arrive at the net paycheck amount for your employees and accumulate the payroll tax and tax liability payments to remit to the proper agencies.

Staying organized, saving time, and avoiding errors are some of the biggest reasons why a lot of small business owners decide to use payroll software such as QuickBooks Payroll. Some of the other benefits of using QuickBooks Payroll include automation; this will be the ability to run your payroll and process direct-deposit every pay period, automatically. Depending on the version of QuickBooks Payroll you have, you could have access to expert assistance to set up your payroll, which could be a daunting task for a first-time employer doing it on their own. 

You also have the ability to print checks with the pay stubs if you don't want to process via direct-deposit. With QuickBooks Payroll Elite, you can rely on a payroll expert to set up your payroll, review your tax filings, and take responsibility for potential mistakes if they happen to arise. As you can see, calculating employee paychecks could be difficult but using software, such as QuickBooks Payroll can be a valuable alternative to doing it manually.

Still, the advice is to hire professionals or get virtual bookkeeping services that will help you to go through all this. Some service providers are providing you these services on online accounting software of your choice could be any like Quickbooks through which your data will be saved on the cloud and it will be much easier and affordable.