Businesses have to calculate how much money must be withheld from employee paychecks to send to the IRS to cover tax payments. It’s an important task as employers have to be careful and properly calculate everything to ensure that employees are taxed at the correct rate.
Employers use Form W-4 and the IRS income tax withholding tables to calculate withholding tax. The IRS income tax withholding contains instructions on how much to withhold during a specific fiscal year.
Businesses need various documents to properly calculate tax withholdings. There are two different methods to calculate tax withholdings. In this article, you will learn more about the topic, what you will need to do proper calculations, and how to calculate withholding tax.
Understanding Tax Withholding
Every time an employee gets a paycheck from the employer, the paycheck includes information about taxes withheld. It’s because the employer has to calculate and withhold taxes on every employee and send them to the IRS – Internal Revenue Service.
The IRS collects payments through tax withholdings all year long. When it’s time to file taxes, employees determine whether their employers withheld enough. If enough, then employees don’t owe to the state. But if employers withhold not enough, then employees have to pay more. If the employer withholds too much, then they get reimbursement.
How to Calculate Withholding Tax: Step-by-Step Guide
Businesses need enough information to make the process of calculating withholdings as smooth as possible. They should also take care of other aspects like choosing a calculation method. Continue reading to find out what you need to calculate your employees’ tax withholdings properly.
Collect Documentation
The very first step is to collect all the necessary documents. Without proper documentation, it’s impossible to calculate withholding tax. Calculations depend on several details, so collect W-4 forms beforehand. It’s a form every employee should receive as soon as they start working at a company.
It’s also critical to download relevant withholding tax tables and the IRS worksheet withholding tax tables, and the IRS worksheet. You can find relevant forms on the IRS website, or if an accountant is doing taxes, then they know where to get relevant tables.
Review Employees’ W-4 Forms
The next important step is to ensure all W-4 forms are filled out correctly. Any business with employees needs to hand these forms to their employees to collect the data necessary to calculate their tax withholdings.
It’s a good idea to have someone responsible for revising these forms as soon as they are submitted to avoid further confusion when making calculations every month. Here is what a Form W-4 should contain:
- Basic personal information. The form should include the employee’s name, surname, address, Social Security number, tax filing status (single, jointed, head of household, etc.).
- Information about a second job. Employees must fill out this section if they have a second job or if they are married and a spouse has a job.
- Dependent tax credits. Another part that may be skipped by employees if they don’t have dependents. Employees add data about their kids and dependents to lower their withholdings. For example, a child under 17 guarantees $2,000 of claimable credits. Other dependents are $500 each.
- Information about additional taxes that can be withheld. This section includes withholding for additional income, such as self-employment or retirement income, any non-standard deductions, etc.
The form has to be signed by the employee. If the form contains every necessary detail, there won’t be any problems calculating tax withholdings.
Pay attention to withholding allowances that employees add to their W-4 forms. These allowances are exceptions that employees use to claim payments from federal income tax. Allowance is not a refund, and it’s just an exception that an employee chooses to use to reduce federal tax on their income. These exceptions shouldn’t be withheld from paychecks.
Check Payroll Information
Collect financial data from payroll to be able to see how much to withhold from employees’ paychecks. The data needed for calculations include:
- Payroll schedule details, it should also include how often employees receive paychecks according to a payroll schedule.
- The gross pay amount for the pay period. It could be a total amount paid to an employee for the pay period or a full salary, taxable wage.
Make sure to keep all records properly to do all calculations quickly. You may also use a tax withholding calculator to make things easier.
Pick a Calculation Technique
You can calculate withholding tax upon getting all W-4 forms, payroll information, and other details. But first, choose a suitable method to do calculations. Choose one of these two methods.
Percentage Method
It is more complex than the next example, but you can find all the necessary instructions in the IRS Publication 15-T. When choosing instructions, make sure you look at the right ones. There are different instructions for businesses using automated and manual payroll systems.
A downloadable worksheet helps with calculations. It gives clear instructions on how to determine an employee’s wage amount, accounting for tax credits, and doing the final calculation on how much needs to be withheld.
Wage Bracket Method
This is a less complicated method that businesses can choose. An accountant or other responsible person has to use the IRS income tax withholding tables to find each employee’s status to calculate withholdings. All the instructions for this method are published in the IRS Publication 15-T.
Calculating Annual Tax Withholdings
When we already know the monthly withholdings, it is easy to calculate the annual amount. For example, each period, you withhold $200 and receive payments twice a month. To calculate the sum per year, you need:
Sum of monthly withholdings x Amount of periods = $200 x (12 x 2) = $4,800
As a result, you would withhold $4,800 in taxes each year.
Final Thoughts
Calculating tax withholdings is an important process. It needs to be done, just like paying for your car insurance. To make things easier, you can hire a professional accountant to help with monthly tax withholdings.
Professional accountants make sure that employees don’t owe anything to the IRS at the end of the tax year. It’s also possible to use the Bureau of Internal Revenue to calculate tax withholding for each employee automatically.