LO3: Compute FIT Withholdings Using a) Percentage Method; b) Wage-Bracket Method, and other options.
Learning Objective
Compute FIT withholdings using a) percentage method; b) wage-bracket method, and other options.How to Calculate Withholding Based on Allowances (Source IRS.gov)
Federal income tax withholding is based on the number of allowances an employee includes on her W-4 form and the IRS tax withholding tables, or Circular E. Some state revenue agencies require that you use a system similar to federal income tax withholding to determine state income tax. To understand how allowances apply to withholding, regard allowances as an amount that reduces the amount of an employee’s pay that is subject to taxation. To make this reduction, you must know the amount that the agency gives per allowance based on the employee’s pay period.Wage Bracket Method
Under the wage bracket method, find the proper table (on pages 46–65) for your payroll period and the employee's marital status as shown on his or her Form W-4. Then, based on the number of withholding allowances claimed on the Form W-4 and the amount of wages, find the amount of income tax to withhold. If your employee is claiming more than 10 withholding allowances, see below.
Adjusting wage bracket withholding for employees claiming more than 10 withholding allowances. The wage bracket tables can be used if an employee claims up to 10 allowances. More than 10 allowances may be claimed because of the special withholding allowance, additional allowances for deductions and credits, and the system itself. Adapt the tables to more than 10 allowances as follows:
- Multiply the number of withholding allowances over 10 by the allowance value for the payroll period. The allowance values are in Table 5 below.
- Subtract the result from the employee's wages.
- On this amount, find and withhold the tax in the column for 10 allowances.
Example - Wage-Bracket Method
Employee John SmithMarital Status : Single
No. of Allowances: 3
Salary: $1,200 Semi-Monthly
Federal Income Tax Withheld: $151 See Illustration
Percentage Method An employee's federal income tax withholding depends on her W-4 form and the IRS Circular E's tax-withholding tables. As an employer, you can use the Circular E's wage bracket method to get the exact withholding if the employee claims 10 allowances or less on her W-4 and if her wages are within the wage bracket's income range. If she claims more than 10 allowances, earns more than the wage bracket's income limit, or if you do not want to use the wage bracket method, you can apply the percentage method. Follow IRS rules to calculate federal income tax using the percentage alternative.
Use these steps to figure the income tax to withhold under the percentage method.
- Multiply one withholding allowance for your payroll period (see Table 5 below) by the number of allowances the employee claims.
- Subtract that amount from the employee's wages.
- Determine the amount to withhold from the appropriate table Link.
Table 5. Percentage Method—2016 Amount for One Withholding Allowance
Payroll Period | One Withholding Allowance |
---|---|
Weekly | $77.90 |
Biweekly | 155.80 |
Semimonthly | 168.80 |
Monthly | 337.50 |
Quarterly | 1,012.50 |
Semiannually | 2,025.00 |
Annually | 4,050.00 |
Daily or miscellaneous (each day of the payroll period) | 15.60 |
Example. An unmarried employee is paid $800 weekly. This employee has in effect a Form W-4 claiming two withholding allowances. Using the percentage method, figure the income tax to withhold as follows:
1. | Total wage payment | $800.00 | |
2. | One allowance | $77.90 | |
3. | Allowances claimed on Form W-4 | 2 | |
4. | Multiply line 2 by line 3 | $155.80 | |
5 | Amount subject to withholding (subtract line 4 from line 1) | $644.20 | |
6. | Tax to be withheld on $644.20 from Table 1—single person, Table Link | $81.23 |
Go to Table 1 (a) Single Person
$644.20 is OVER $222 BUT NOT OVER $767 so to compute amount to withhold
$17.90 plus $15% of Excess over $222
Computation: $17.90 + 15% (644.20-222) = $17.90 + 63.33 = $81.23
Annual income tax withholding. Figure the income tax to withhold on annual wages under the Percentage Method for an annual payroll period. Then prorate the tax back to the payroll period.
A married person claims four withholding allowances. She is paid $1,000 a week. Multiply the weekly wages by 52 weeks to figure the annual wage of $52,000. Subtract $16,200 (the value of four withholding allowances for 2016) for a balance of $35,800. Using the table for the annual payroll period on page 45, $3,160.00 is withheld. Divide the annual tax by 52. The weekly income tax to withhold is $60.77.
Example.
Example.
Alternative Methods of Income Tax Withholding Rather than the Wage Bracket Method or Percentage Method described in this section, you can use an alternative method to withhold income tax. Pub. 15-A describes these alternative methods and contains:
• Formula tables for percentage method withholding (for automated payroll systems),
• Wage bracket percentage method tables (for automated payroll systems), and
• Combined income, social security, and Medicare tax withholding tables.
Some of the alternative methods explained in Pub. 15-A are annualized wages, average estimated wages, cumulative wages, and part-year employment.
Supplemental wages identified separately from regular wages. If you pay supplemental wages separately (or combine them in a single payment and specify the amount of each), the federal income tax withholding method depends partly on whether you withhold income tax from your employee's regular wages.
Regardless of the method you use to withhold income tax on supplemental wages, they are subject to social security, Medicare, and FUTA taxes.
Vacation pay. Vacation pay is subject to withholding as if it were a regular wage payment. When vacation pay is in addition to regular wages for the vacation period, treat it as a supplemental wage payment. If the vacation pay is for a time longer than your usual payroll period, spread it over the pay periods for which you pay it.- If you withheld income tax from an employee's regular wages in the current or immediately preceding calendar year, you can use one of the following methods for the supplemental wages.
- Withhold a flat 25% (no other percentage allowed).
- If the supplemental wages are paid concurrently with regular wages, add the supplemental wages to the concurrently paid regular wages. If there are no concurrently paid regular wages, add the supplemental wages to alternatively, either the regular wages paid or to be paid for the current payroll period or the regular wages paid for the preceding payroll period. Figure the income tax withholding as if the total of the regular wages and supplemental wages is a single payment. Subtract the tax withheld from the regular wages. Withhold the remaining tax from the supplemental wages. If there were other payments of supplemental wages paid during the payroll period made before the current payment of supplemental wages, aggregate all the payments of supplemental wages paid during the payroll period with the regular wages paid during the payroll period, calculate the tax on the total, subtract the tax already withheld from the regular wages and the previous supplemental wage payments, and withhold the remaining tax.
- If you didn't withhold income tax from the employee's regular wages in the current or immediately preceding calendar year, use method 1-b. This would occur, for example, when the value of the employee's withholding allowances claimed on Form W-4 is more than the wages.
Example 1. You pay John Peters a base salary on the 1st of each month. He is single and claims one withholding allowance. In January he is paid $1,000. Using the wage bracket tables, you withhold $50 from this amount. In February, he receives salary of $1,000 plus a commission of $2,000, which you combine with regular wages and don't separately identify. You figure the withholding based on the total of $3,000. The correct withholding from the tables is $336.
Example 2. You pay Sharon Warren a base salary on the 1st of each month. She is single and claims one allowance. Her May 1 pay is $2,000. Using the wage bracket tables, you withhold $186. On May 14 she receives a bonus of $1,000. Electing to use supplemental wage withholding method 1-b, you:
- Add the bonus amount to the amount of wages from the most recent base salary pay date (May 1) ($2,000 + $1,000 = $3,000).
- Determine the amount of withholding on the combined $3,000 amount to be $336 using the wage bracket tables.
- Subtract the amount withheld from wages on the most recent base salary pay date (May 1) from the combined withholding amount ($336 – $186 = $150).
- Withhold $150 from the bonus payment.
Example 3. The facts are the same as in Example 2, except you elect to use the flat rate method of withholding on the bonus. You withhold 25% of $1,000, or $250, from Sharon's bonus payment.
Example 4. The facts are the same as in Example 2, except you elect to pay Sharon a second bonus of $2,000 on May 28. Using supplemental wage withholding method 1-b, you:
- Add the first and second bonus amounts to the amount of wages from the most recent base salary pay date (May 1) ($2,000 + $1,000 + $2,000 = $5,000).
- Determine the amount of withholding on the combined $5,000 amount to be $771 using the wage bracket tables.
- Subtract the amounts withheld from wages on the most recent base salary pay date (May 1) and the amounts withheld from the first bonus payment from the combined withholding amount ($771 – $186 – $150 = $435).
- Withhold $435 from the second bonus payment.
How to Calculate Federal & State Taxes for Gross-Up Purposes When you reimburse an employee for moving expenses or give your employee a bonus, you can "gross up" the amount to cover the tax burden. Because the IRS considers bonuses and reimbursement for moving expenses taxable income, the employee must pay taxes on the monetary gain. If you promise your employee a specific amount, it is your responsibility to cover the tax liability by "grossing up" the payment. The gross-up amount should equal the amount the employee is owed plus enough money to cover the federal and state taxes associated with the tax liability.
Step 1
Determine the employee's total tax rate by adding the federal and state tax percentages. Generally, you must use a supplemental tax percentage according to the employee's income tax bracket using the IRS Circular E and the tax form or publication pertaining to your state's income tax rules. For example, if the employee must pay 25 percent of his income to federal and state and subject to 7.65% FICA (6.2% OASDI+1.45%HI), the total tax on the bonus or reimbursement is 32.65 percent (25 + 7.65).
Step 2
Subtract the total tax percentage from 100 percent to determine the net tax percentage. For example, assume that your employee must pay 31 percent on a $10,000 bonus. The net tax percentage is 67.35 percent (100 - 32.65).
Step 3
Divide the employee's bonus amount by the net tax rate to determine the gross amount of the bonus. Using the previous example, the gross amount of the bonus, accounting for federal and state taxes due, is $14,847.81 ($10,000 / .6735).
Step 4
Subtract the gross amount that you owe the employee from the agreed-upon bonus to determine the gross-up federal and state tax amount. Using the previous example, the gross-up amount for federal and state income taxes is $4,847.81 ($14,847.81 - $10,000).
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