How to Calculate Employee Withholding
Large institutions and accounting services use automated payroll systems to calculate employee withholdings. However, you can still calculate payroll deductions manually. For small businesses with just a few employees, this is frequently a more cost-effective option. Remember to instruct all new employees to complete and submit a W-4 form by the end of their first pay period so you have their information at hand when you start to calculate employee withholdings.
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Things You'll Need
- Employee W-4 Form
- IRS Publication 15, Circular E
- Current tax tables
- Employee year-to-date earnings
- State/local tax instructions
Instructions
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1
Find the employee's total compensation (also called gross wages) for the pay period, excluding nontaxable items like mileage reimbursements. Compensation includes salary or hourly wages plus overtime. Add in other earnings like tips or commissions.
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2
Figure Social Security tax. Unless an employee's year-to-date (YTD) earnings have reached the salary cap for the year, multiply the gross wages by 6.20 percent to find Social Security tax. Once YTD earnings reach the annual cap, stop taking out Social Security tax. Look in IRS Publication 15, Circular E (Employer Tax Guidelines) for the current cap amount.
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3
Find the amount of Medicare tax to withhold. Multiply gross wages by 1.45 percent. There is no cap on earnings subject to Medicare tax.
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4
Determine taxable earnings subject to federal income tax. Look in Publication 15, Circular E for the amount of one withholding allowance for the pay period. Multiply this amount by the number of allowances claimed on the employee's W-4 form. For example, in 2009, the amount was $70.19 for a weekly pay period. If an employee claimed three withholding allowances, the total would be $210.57. Subtract this amount from the employee's gross wages. You should also deduct tax-exempt deductions like contributions to a 401k plan. The result is the taxable earnings used to figure federal income tax withholding.
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Calculate the employee's federal income tax. Locate the tax table for the employee's filing status and pay period. Federal income tax works on a tax bracket system, with higher percentages deducted as earnings increase. For example, in 2009, the first $138 of taxable income had zero tax for an employee paid weekly and filing single. From $138 to $200 the rate was 10 percent. From $200 to $696 federal tax withholding was $6.20 plus 15 percent of the amount over $200. Each higher tax bracket had its own tax percentage up to a maximum of 35 percent for earnings more than $7,120 a week.
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Order instructions from your state or local department of revenue (or taxation). Each government that levies income taxes has its own formula. Follow the instructions to calculate state or local employee withholdings.
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Tips & Warnings
Keep in mind that an employer must also calculate and remit employer-paid payroll taxes along with those withheld from employee earnings. These include employer contributions to Social Security/Medicare plus federal and state unemployment taxes.
