Employers are required by federal law to withhold and pay income and FICA taxes from employee paychecks. It all seems pretty straightforward until you start looking through the reams of IRS information that ostensibly explain this highly complex system. For example, consider your two options for determining withholding: wage bracket or percentage calculations. What's the difference?
It is hard to imagine the IRS making withholding any more complicated than it already is. Perhaps that's why so many people have turned over their regular payroll processing duties to us. Having said all of that, you have the two previously mentioned options for determining how much to withhold for income tax. You need to know and understand the differences between them.
Note that both Social Security and Medicare taxes are based on fixed numbers. They don't ever change, so there's no need to go through any complex calculations. Total withholding for Social Security is 6.2% of the employee's earnings for that pay period. Medicare is taxed at a rate of 1.45%. Employers contribute equal amounts of both and submit them along with employee contributions.
Wage Bracket Calculations
The wage bracket calculation for income tax is the calculation that most employers use most of the time. It is the simplest of the two procedures – if there is such a thing with the IRS – because the government has done most of the work already. Employers need only look at published tables to determine how much to withhold based on a worker's marital status, allowances, etc.
Wage bracket calculations can still get complicated in two ways. First is deciding what table to use. There are no fewer than 17 tables in the 2018 guide printed by the IRS. Employers must consider pay frequency and other factors in order to choose the correct table.
If that's not enough, the tables are not intended for use when the employee earns more than a certain amount or has more than 10 allowances. Although exceeding 10 allowances is unusual in this day and age, it's not unheard of. Employers must switch to the percentage method to accommodate employees with extra allowances.
The Percentage Method
The IRS designed the percentage method to have no wage or allowance limits. Unfortunately, calculations based on the percentage method are quite complex. We will attempt to explain it as simply as possible.
Employers must start by determining the monetary value of each of the affected employee's allowances. All those values are then added to come up with a total value. This total is subtracted from the worker's earnings for that pay period. From there, the employer would consult the 2018 Circular E table to find the applicable percentage. The employer multiplies the difference between employee earnings and his or her total allowances by the percentage to arrive at the correct amount of income tax.
This may sound simple, but it is not. The value of individual allowances differs. Then those allowances have to be adjusted according to pay frequency. For example, do you pay weekly or biweekly? For a single worker with just two excess allowances being paid biweekly, coming up with the right amount to withhold requires a five-step calculation. There is a lot more to it than just consulting the wage bracket table.
It is things like this that make our tax laws so frustrating. Nonetheless, it is what it is. If you are struggling with income tax withholding, perhaps it's time for you contact us to learn more about our payroll services. We take the headaches out of payroll processing by doing all the work for you.