Are You Withholding Enough Tax From Employee Paychecks?
Are you withholding enough tax from employee paychecks? Check out the withholding calculation process below to determine if your withholding calculations are correct. You will need to include both income taxes (federal and state, if applicable) and FICA taxes (Social Security and Medicare).
Federal Income Tax Withholding and Form W-4
As an employer, your business can only calculate withholding for federal income taxes based on the information given to you by employees. Each employee must complete Form W-4 at hire. This form includes information about the employee's marital status, the total number of allowances to be considered, and any additional amount the employee wants withheld from each paycheck.
Employees may change the information on their W-4 forms with each pay period, an unlimited number of times.
2017 Tax Reform Act- How it Will Affect Withholding Calculations
The 2017 Tax Reform Act has made major changes that will affect withholding for employees. The major effect of this reform is that tax rates have been lowered, which means that some employees may be withholding too much.
Many employees will want to change their withholding so they won't withhold too much. That means changing their W-4 forms.
The new law also changes the tax brackets, which means the withholding tables you use to calculate withholding for employees for 2018 wages have changed.
The IRS has released new withholding tables that you must use for calculating withholding for employees starting in 2018. A new W-4 form has also been released for 2018 (IRS final version in the link).
What You Will Need for These Calculations
You will need the employee's most recent Form W-4, completed by the employee. You will also need this information:
- The gross pay for each employee for the pay period.
- Income tax withholding tables for the current year, from IRS Publication 15-A.
- FICA tax withholding percentages for the current year. See the details in this article about how to calculate FICA tax withholding.
- The maximum Social Security withholding amount for the current year.
How to Calculate the Withholding Amount
The amount withheld from an employee's paycheck depends on:
- The payroll period (weekly, bi-weekly, semi-monthly, or monthly), This is the frequency with which you pay employees, the amount of time for that pay period.
- Whether the employee is single or married (from the W-4 Form)
- The number of allowances claimed by the employee, (from the W-4 Form)
- The amount of gross pay for the period (the total amount of pay for that pay period, from your calculations of gross pay, and based on whether the employee is salaried or hourly.
- Any additional amounts that the employee requests be withheld (from the W-4 Form
Withholding allowances are used by the employee to give additional information that may affect the employee's taxable income. These allowances are included and totaled on a Withholding Allowances worksheet. The Allowances are listed on items A through G of this worksheet and the total is brought over to the W-4 form, on Line 5. The worksheet does not have to be shown to the employer; it can be saved by the employee.
How the Calculation Is Done
The calculation uses a worksheet in IRS Publication 15-A, Employer's Supplemental Tax Guide. Be sure you are using the correct guide and year. The correct guide begins on Page 32 of the 2018 guide. Look for the Guide titled: Wage Bracket and Percentage Method Tables for Computing Income Tax Withholding From Gross Wages (For Wages Paid in 2018)
You can use one of two methods for the calculation:
The Wage Bracket Method: In the tables, find the range the employee's wages fall under. Then use the allowances the employee is claiming from their W-4 to find the correct amount.
The Percentage Method: This method is more complex and it involves first finding the amount of one withholding allowance, based on the employee's payroll period. Then, multiply this number by the number of allowances the employee claims and subtract that from the employee’s wages. Then, find the range that is correct for that number and calculate the tax amount.
Here is how the calculation is done for the wage bracket method:
- Find the table for the payroll period your company uses. Let's say it is a bi-weekly payroll period.
- Then look for the marital status column for that employee. Let's say the employee is single.
- Then look down the rows in the "single" section for the number of allowances. Let's say it's 1.
- Then look across this row for the number of gross wages; this amount will be in a category of wages "over" one number, "but not over" another. For this example, let's say bi-weekly wages are $603, which is over $598.77 but not over $1690.77.
- Finally, follow the category line across to the correct number of withholding allowances. There are two more calculations to perform.
- Subtract the amount noted in Column C from gross wages. In this case, the amount to be subtracted is $361.44, leaving $237.33.
- Then multiply the result from your Column C by the percentage in Column D, which is 15 percent in this case.
- Finally, you have the withholding amount of $35.60 (rounded up).
If the employee has requested an additional amount to be withheld, this amount is added to the withholding amount for a grand total withholding.
This IRS Withholding Calculator is for employees to use to estimate the withholding for federal income taxes, based on their individual situation.
State and Local Income Tax Withholding
Employers must withhold state and local income taxes from employees. Some states have no state income tax, so this process isn't necessary for those states.
The process for withholding state income tax is similar to the process for federal income tax. State tax is withheld on the employee's gross pay. The details for each state vary, so check with your state taxing authority to find out what is required.
How to Calculate FICA Tax Withholding
To calculate the FICA taxes to be withheld from employee paychecks:
- Multiply the employee's gross pay by the FICA withholding amounts for Social Security (6.2 percent) and Medicare (1.45 percent). Keep these totals separate.
- Check to make sure the employee's total Social Security withholding for the year doesn't exceed the maximum for the year.
- If the employee's gross pay reaches a specific level, you must withhold an additional amount of Medicare tax (0.9 percent) for the rest of the year. Find out more about the Additional Medicare Tax in this article.
Other Ways to Calculate Employee Tax Withholding
This calculation is pretty tricky, and if you have many employees, you will want to find other ways of doing the calculations. If you are using accounting software, you can purchase a payroll module to help you with these calculations, or you can ask your bookkeeper or accountant to do these calculations for you.
More About Types of Employment Taxes