How Employers Compute Employee Payroll Taxes

written by Connor O'Mealy

Any business that has employees is required to withhold income taxes on payments to each employee. Each employee must fill out their Form W-4 and the Employee’s Withholding Allowance Certificate, and then provide both of those documents to their employer. Employees can claim a personal exemption, and an exemption for a spouse or child, in order to determine the number of withholding allowances for the employee. The employer then uses the tables in the IRS publication Circular E of the Employer’s Tax Guide to determine which withholding method to use and how much income tax to withhold from the employee for the year.

The two common income tax withholding methods are:

The Percentage Method

The employer selects one of eight tables based on how long the payroll periods are. If the employer does not use a payroll period, then the daily or miscellaneous table should be used. After determining the appropriate table, the employer determines the amount of wages that are to be used as a base calculation. This calculation is determined by subtracting the number of withholding allowances from the previous determined wages for the payroll period. The result is net wages subject to withholding. That amount is then used in the withholding tables to realize the withholding amount.

Wage Bracket Method

For each employee, the employer must determine the payroll period, wages paid during the period, withholding exemptions, and marital status. The wage brackets are then used to calculate the amount of income tax to be deducted and withheld by using gross wages. There is no exemption amount deduction with this method. The Wage Bracket Method typically produces similar results to the percentage method. This method can only be used to assess information in payroll periods that fall before the first quarterly payroll period.

Employment taxes to pay attention to:

Federal Insurance Contributions Act (FICA or Social Security) and Federal Unemployment Tax Act (FUTA) taxes:

•  FICA consists of two taxes: the old-age, survivors and disability insurance (OASDI) tax, equal to 6.2 percent on both the employer and employee; and the hospital insurance (HI) tax, equal to 1.45 percent on both the employer and the employee. FICA taxes thus have a combined rate of 7.65 percent. The OASDI tax is subject to a wage limit, set at $118,500 for 2015 and 2016. Wages above that limit are exempt from the OASDI tax. However, there is no limit on the HI tax. If the employee has wages above $200,000, the employer must withhold the additional 0.9 percent Medicare tax from all wages above that threshold.
• FUTA tax is 6 percent of all wages paid during the calendar year and is up to a $7,000 wage limit. These amounts are owed by the employer and are not deducted from the employee’s wages. The employer can claim a credit for contributions to state unemployment insurance funds. The maximum credit is 90 percent of the 6 percent rate, or 5.4 percent.

If you have any question about calculating payroll taxes, please contact our office at 417-881-0145.