How to Calculate Payroll Deductions

If you are brand new to running payroll, having employees, and entering payroll deductions, this is a quick instruction manual of how to think about entering correct numbers into your payroll software. NOTE: some deductions are post tax and some are pre-tax, confirm the taxable / tax-free nature of the deduction before entering the deduction into the payroll system.

Let’s say you have a request (ex. Health insurance, child support order, etc.) that is shown as a MONTHLY cost. For example, you receive a court order that commands you (the employer/company) to withhold $500 per month for child support. This order is commanding you to, “subtract $500 from the employee’s paycheck every month and mail it to the court / child support center”.

The employee makes $18 per hour and you run payroll bi-weekly… how do you do this?!

• Step 1: convert the MONTHLY cost into a PER PAYROLL cost.
  • In this example, payroll is done biweekly. Therefore, we know there are 26 payrolls per year. (52 weeks per year… every 2 weeks… is 26 payrolls)
  • The $500 per month child support order can be multiplied by 12 to express the amount as a yearly amount. This is $6000 of child support per year.
  • $6000 of child support over 26 pay periods = $6000 divided by 26 = $230.77
  • You should withhold $230.77 from the employee’s paycheck every pay period.
• Step 2: Enter into Payroll System – tell your payroll provider or enter $230.77 into the software. Contact your payroll provider / read the instructions for technical details (i.e. where & what to click on the computer screen).
• Step 3: Send child support money to whomever you are to send it to… in a TIMELY manner. Remember, this is NOT your money. Not sending it in is the equivalent of theft.

Payroll Deductions for Employee Benefits / Health Insurance

Let’s say that you now offer health insurance and have decided to pay for 50% of the cost. To complicate matters, the cost of the insurance changes based on the age of each employee!!

Joel at age 36 = $386.74 per month total health insurance cost. Since you have agreed to pay 50% of the cost, Joel will be paying $193.37 per month and the company will be paying $193.37 per month.

Jenelle at age 54 = $563.88 per month total health insurance cost. Since you have agreed to pay 50% of the cost, Jenelle will be paying $281.94 per month and the company will be paying $281.94 per month.

We now do the same process as before. Let’s do this for Jenelle:

• Step 1: convert the MONTHLY cost into PER PAYROLL cost.
  • In this example, payroll is done biweekly. Therefore, we know there are 26 payrolls per year.
  • The $281.94 per month cost for Jenelle can be multiplied by 12 to express the amount as a yearly amount. This is $3383.28 of employee paid health insurance premium per year.
  • $3383.28 of health insurance premium over 26 pay periods = 3383.28 divided by 26 = $130.13
  • You should withhold $130.13 from the employee’s paycheck every pay period.
• Step 2: Enter into Payroll System – tell your payroll provider or enter $130.13 into the software. Contact your payroll provider / read the instructions for technical details (i.e. where & what to click on the computer screen). Employee benefits are “PRE-TAX” so make sure you click the little checkbox or whatever to make these deductions pre-tax.
• Step 3: Pay the health insurance bill… in a TIMELY manner. Remember, this is NOT your money.

When to Start Payroll Deductions

For employee benefits, you (i.e. the company) must become a bank / lender.  You will pay the invoice, essentially providing a short term loan to the employee for their share of the insurance premiums (or other benefits).  Then you will recover this money via payroll deductions.  IF the employee leaves at the beginning of the month, you should take a larger deduction from the final paycheck to cover the cost of the benefits. SOME companies choose to take the entire payroll deduction at the START of the month with the first payroll in order to reduce the “bank-like” quality of this relationship.

This is how you would take deductions at the start of the month for Jenelle:

• Jenelle at age 54 = $563.88 per month total health insurance cost. Since you have agreed to pay 50% of the cost, Jenelle will be paying $281.94 per month and the company will be paying $281.94 per month.
• The first payroll of each month, withhold $281.94
• Your payroll software may or may not be able to do this.