The tax system in the United States is a pay-as-you-go system. Employers and businesses deposit payroll taxes quarterly, while employees pay their taxes from each paycheck. It is the employer's responsibility to calculate and withhold the correct amount of taxes and forward the money to the Internal Revenue Service when due. It is the employee’s responsibility to inform the employer how to compute withholding taxes by giving the employer's payroll department a Form W-4. Tax withholding varies depending on the employee's filing status and the number of allowances claimed.
1. Obtain a copy of the IRS tax withholding tables showing the amount of money to withhold from an employee's paycheck, depending on her filing status and the number of allowances claimed. The tables are included in IRS Publication 15: Employer's Tax Guide.
2. Calculate the employee’s base pay, using the method indicated by her pay plan. Add in any incentives, such as bonuses and commissions. Include the valuation of any taxable fringe benefits, such as a company car. If benefits are paid under a cafeteria plan for health insurance or a flexible spending account, subtract that amount from the total wages to figure withholding.
3. Multiply the amount from Step 2 by 4.2 percent to calculate the Social Security withholding applicable in 2011, and by 1.45 percent to figure the amount to withhold for Medicare tax. The Social Security withholding rate is scheduled to return to 6.2 percent in 2012. If the employee has earned more than $106,800 for the year, do not withhold Social Security taxes on wages above that amount but continue to withhold Medicare taxes.
4. Subtract from the total pay after benefits (from Step 2) any pre-tax contributions to retirement plans, such as 401k or 403b plans. The result is the amount used to calculate federal income tax withholding.
5. Find the appropriate bracket in the table applicable to the employee’s situation. The tables are based on the employee’s pay period: weekly, bi-weekly, semi-monthly or monthly. Each filing status also has its own table. Using the correct table, find the bracket that corresponds to the employee’s taxable pay from Step 4. Follow the columns to the right until you reach the column with the specified number of withholding allowances. This is the amount of federal taxes to withhold.
- Consider using a payroll service to calculate employee paychecks. The service can handle the necessary calculations and even forward withheld taxes to the IRS. Online calculators may make this process easier as well.
- The IRS allows employers to use a percentage withholding method to figure the amount of taxes to withhold. This method may be more suited to an employer using a spreadsheet program to calculate withholding.
- Remit withheld taxes to the IRS on a timely basis. The IRS has broad powers to collect delinquent withholding taxes from employers that fail to meet this obligation.
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