How to Budget for Labor Costs and Payroll Tax Expenses

May 23

Labor costs are one of the biggest overall expenses for any business, but especially for small businesses. According to the U.S. Small Business Administration, labor costs can account for up to 50% of a company's operating expenses. Payroll taxes are a necessary expense for any business with employees which is why it is essential for your business to budget for labor costs and payroll taxes accurately.

Calculating payroll costs is especially essential for businesses that bid for project-based work, such as construction companies. New employers should also understand the costs involved in hiring their first employee. To avoid surprise payroll tax costs, accurately budget your payments from the start. Below are some steps and tips to help you create a payroll tax budget.

How do Payroll taxes impact your overall labor budget

Below are the necessary steps your business should take to budget for labor costs and payroll tax expenses. By following these steps, you can create a labor budget that will help you stay profitable and avoid surprises.

Understand the different types of payroll taxes

There are a number of different payroll taxes that your business is responsible for, including:

Federal income taxes: These taxes are withheld from an employee's paycheck and sent to the federal government. The amount of federal income tax that is withheld depends on the employee's filing status and taxable income.
Social Security taxes: Social Security is a government program that provides retirement, disability, and survivor benefits to eligible individuals. The Social Security tax rate is 6.2% for both employees and employers.
Medicare taxes: Medicare is a government program that provides health insurance to eligible individuals, including the elderly, disabled, and low-income individuals. The Medicare tax rate is 1.45% for both employees and employers.
State and local income taxes: These taxes are imposed by state and local governments. The types of state and local taxes that are imposed vary from state to state.
State and federal employer-paid unemployment tax: Employers pay these taxes to the federal and state government to help fund the unemployment insurance program. This program provides temporary financial assistance to workers who have lost their jobs through no fault of their own. The state unemployment tax rate varies from state to state.

Estimate your total labor costs

Your total labor costs include the wages, salaries, benefits, and payroll taxes for your business. The simplest way to estimate your labor costs is to multiply the number of employees by their average hourly wage or salary. Once this is done, add in the cost of benefits and payroll taxes. Below is a payroll cost example including gross pay plus your employer taxes.

Payroll Cost Example - Gross Plus Employer Taxes

Gross Pay		$1,000
Employer Social Security	6.2%	$62.00
Employer Medicare	.45%	$4.50
State Unemployment Tax	3.4%	$34.00
Federal Unemployment Tax	0.6%	$6.00
Total Cost of Pay		$1,106.50

Note: State unemployment tax rates vary by state and employer. Federal unemployment tax caps at $42.00 per year per employee.

Factor in seasonal fluctuations

If your business experiences seasonal fluctuations in sales, it is important to factor those fluctuations into your labor budget. For example, if your business is busiest during the holiday season, you'll need to hire more staff to handle the increased workload. It is beneficial to prepare for these fluctuations before your business is in the midst of a busy season.

Build in a contingency fund

Even if you do your best to budget accurately, there's always the possibility that your labor costs will exceed your expectations. By building a contingency fund into your budget, you will give yourself some wiggle room in case of unexpected expenses.

Consider Workers compensation insurance

Workers' compensation insurance is a type of insurance that covers employees who are injured or become ill on the job. It is required in most states and provides benefits to employees, such as medical expenses, lost wages, and rehabilitation. Workers' compensation insurance is important because it protects both employees and employers. Employees are protected from having to pay for their own medical expenses and lost wages if they are injured on the job. Employers are protected from lawsuits from employees who are injured on the job.

A licensed insurance broker can provide quotes based on your industry and estimated payroll gross. You can also inquire about pay-as-you-go programs from your payroll service provider that allows for incremental premium payments rather than a lump sum upfront premium payment.

Factor in company paid time off and retirement plans

It is important to factor in the cost of paid time off and retirement plans. This includes both the company policies included in your handbook and state mandated policies. Mandated sick and leave pay and employer contributions to retirement plans should also be factored in.

Track your actual expenses

Once you've created a budget, it's important to track your actual expenses to make sure you're staying on track. This will help you identify any areas where you can cut costs or make adjustments to your budget.

It is recommended to track your expenses regularly to avoid a backlog. By devoting a small amount of time each week to update your expenses, you can more easily monitor your overall budget and stay on track.

Tips for budgeting labor costs and payroll tax expenses

Here are some additional tips for budgeting for labor costs and payroll tax expenses.

Use a spreadsheet or budgeting software to track your expenses.

Setting up and organizing your labor cost with an efficient tracking system will help you see where your money is going and identify areas where you can cut costs. It will also make it easier to track and update your expenses each week.

Consider using a payroll service to help you with your payroll taxes.

If you are not a payroll tax expert, it is best to hire a payroll service to handle it. They will ensure that your business is compliant with all applicable federal and state laws and regulations, saving you time and money in the long run. A responsive payroll company like Payworks will be a true payroll partner to you, rather than just a payroll system. We pride ourselves on going the extra mile for our clients to not only help them with their payroll, but also help them to understand the overall process.

Learn about Payworks services and request a free consultation.

Take advantage of tax breaks and incentives for small businesses.

Small businesses can reduce labor costs by taking advantage of government programs. There are a number of programs available, so it is important to do some research to find out which ones apply to your business. For example, some high schools and trade schools will offer students credit for work experience. This can be a great way to get qualified employees without having to pay them a full wage.

Get help from a financial advisor or accountant.

If you are not sure how to budget for labor costs, a financial advisor or accountant can help you create a plan that works for your business. Accountants are experts in factoring labor costs into your overall business tax plan.

Tracking labor costs and payroll taxes proactively and accurately is essential for small businesses. By following the steps and tips listed above, you can create a labor budget that will help you stay profitable and avoid surprises. Labor costs are a large portion of your overall business costs, so it is essential to understand them.

If you are looking for a payroll service that will partner with you to help you understand the overall payroll process, Payworks would love to work with you. We offer a wide range of services to meet the needs of small businesses. We are committed to providing our clients with the highest level of service and support.

Dennis Madej