What Wages Are Used to Calculate Withholding?
Wages Used to Calculate Withholding
New Deadline for W-2 Forms
The deadline for filing W-2 annual wage report forms for employee and 1099-MISC annual payment forms for non-employees is now January 31 each year, for the previous year's wages and payments. W-2 forms must be given to employees and filed with the Social Security Administration by January 31, and 1099 forms must be given to non-employees and filed with the IRS by that same date.
Read more about the W-2 and 1099 Tax Report Deadlines.
First, we'll look at the employee's gross pay and then how withholding and employment taxes are calculated from that gross pay. Finally, we'll look at the types of payments not included in withholding.
How is the gross pay for withholding and employment taxes determined?
Gross pay is the amount of an employee's pay calculated each payroll, depending on the employee type. For hourly employees, gross pay is the employee's hourly rate times the number of hours worked, and including any overtime rate payments. For salaried employees, gross pay is the employee's annual salary divided by the number of pay periods in the year. For tax purposes, gross pay may also include:
- Reimbursements to employees for expenses such as meals and lodging and travel
- Pay received for vacation time or sick leave
In other words, gross pay is all payments made to an employee by an employer.
But some of these payments are not included
Withholding for federal income tax is based on wages paid by an employer. For the most part, all calculations for wages subject to withholding (FIT, FICA) are based on gross pay (total W-2 income before any deductions or exclusions) from that employer. The IRS says, "Wages subject to federal employment taxes generally include all pay you give to an employee for services performed.
The pay may be in cash or in other forms. It includes salaries, vacation allowances, bonuses, commissions, and fringe benefits.
How are withholding and employment tax calculated on employee pay?
Employers must withhold certain amounts from employees and pay certain employment taxes to the IRS based on employee wages. But gross pay may be reduced by specific amounts allowed by the IRS. This article explains the types of withholding deducted from employee pay and payable by employers and the types of pay which can be excluded for these purposes.
- Federal income taxes (FIT), withheld based on the information from the employee's W-4 form and the employee's gross pay for a pay period.
- FICA taxes (FICA) (Social Security and Medicare taxes). Social Security taxes are withheld from employee wages, up to the Social Security maximum; Medicare taxes are withheld from employee wages with no maximum, but some higher-paid employees have an additional Medicare tax that must be withheld. FICA taxes are also paid by employers, with no maximums.
- Federal unemployment taxes (FUTA), which are not withheld from employee wages but are paid by the employer based on the employee's gross pay.
Payment not included in wages for withholding.
There are, however, some types of payments by an employer that are not included in wages for the purpose of calculating withholding.
Contributions by an employer to a qualified retirement plan are one common example of "wages" not subject to withholding. IRS Publication 15 lists specific types of payments and whether they can be excluded from calculations for federal income tax, FICA tax, and federal unemployment tax.
Some of the most common categories of wages which may (under specific circumstances) be excluded from employee wages for federal income tax, FICA tax, and federal unemployment tax purposes:
- resident aliens
- disabled workers wages
- employee business expense reimbursements, if part of an accountable plan that meets IRS requirements
- family employees, including children employed by parents, and spouses employed by spouses
- insurance for employees (accident, health, group term life insurance)
- interest on loans
- tips (depending on the monthly amount
How Withholding is Calculated
For the purpose of calculating FIT and FICA, an employer must start with total W-2 wages, then deduct amounts that can be excluded, in order to get a total amount to be used for calculating federal income taxes and FICA taxes.
An example of how federal income tax and FICA taxes might be calculated:
- First, the employee's gross pay is calculated,
- Next, any excludable items are deducted from gross pay for federal income tax withholding purposes, and federal income taxes are calculated
- Any excludable items are deducted from gross pay for FICA withholding purposes and FICA tax withholding is calculated. Some types of payments may be excludable for FIT purposes but not for FICA purposes
- Excludable pay for individual employees is used to reduce that employee's pay for federal unemployment tax purposes. Pay for all employees that is subject to federal unemployment tax is added up and the federal unemployment tax rate is applied to the total payroll
States usually follow federal rules for withholding, but each state is different. Check with your state's department of revenue on state rules for calculating withholding.