Taxes are levied by all governments across the world, to financially support the welfare functions of the state. Payroll tax is an example of direct taxation that is imposed by the government. Here, we have provided the method to calculate payroll taxes.
Payroll tax is defined as tax that an employer deducts or pays on behalf of its employees based on the pay scale of the employees. It includes salaries, allowances, bonuses, commissions and fringe benefits. In the United States, payroll taxes are imposed by the state and federal government. Before we proceed to the concept of payroll taxes and the actual process calculations, let us have a look at taxes and related concepts.
Calculating Payroll Taxes
Payroll period is the period of service for which an employer pays salary/wages to its employees. When an employee has a regular payroll period, the employer withholds income tax for that period even if the employee has not worked for the complete period. For an employee with no regular payroll period, the tax is deducted based on a daily or miscellaneous period. For this you need to find out the number of days in the pay period, including Sundays and holidays.
The first step in the calculation of payroll taxes is to calculate the gross wages of employees. The gross wages are the wages that include all types of allowances and overtime wages. In short, the gross wages include the amount that is taken home by the employee. Federal tax deductions are subtracted from gross wages.
Payroll tax deductions include the following statutory deductions:
- Federal income tax withholding (based on the withholding tables and other tax brackets mentioned in IRS Publication 15 Circular E)
- The social security tax rate for employees is 4.2%, on wages paid and tips received before March 1, 2012. For wages paid and tips received after February 29, 2012, the tax rate is 6.2%
- The social security tax rate for employers is 6.2%.
- The wage base limit is $110,100, for social security.
- Medicare tax is 1.45%, for both employee and employer. There is no wage base limit for Medicare tax.
- State and local income tax withholding.
In some cases you will have to check up with state laws for tax deductions.
Income Tax Withholding
The employer withholds federal income tax from an employee’s salary according to the employee’s form W-4 and the correct withholding table.
- It’s mandatory for every employee to have an IRS W-4 form. The W-4 will help to get the precise tax withholding figures. The W-4 works somewhat like a payroll tax calculator. Tax laws may change over time, so one needs to have an updated W-4 form. This document is available on the official IRS website.
- The amount of federal income tax deducted is based on the marital status of the employee and the number of withholding allowances he is entitled to. An employee is required to complete the W-4 form mentioning the number of withholding allowances.
- The employer deducts income tax based on the filing status and the allowances claimed on form W-4. These withheld amounts are paid to the Internal Revenue Service (IRS) in the employee’s name.
• Refer to the Withholding Calculator given in the IRS website.
Income Tax Withholding Methods
Income tax can be calculated based on the wage bracket method and the percentage method. These methods are based on the information furnished by the employees in the W-4 form. Given below are the steps for payroll tax calculation under the percentage method.
- To withhold tax under the percentage method, you need to multiply one withholding allowance for your payroll period with the number of allowances claimed in the W-4 form.
- Subtract the above amount from the total wages of employees.
- Determine the withholding amount from the appropriate withholding table.
Refer to the table below to know the amount for one withholding allowance in 2012, for different payroll periods, under the Percentage Method.
|Payroll Period||Amount of each Withholding Allowance|
|Daily or miscellaneous||$14.62|
Here we will provide you an example for calculating payroll tax using the Percentage Method.
Example: Let’s calculate the income tax to withhold for an unmarried employee whose weekly wage is $1,000. The employee has claimed 4 withholding allowances in W-4 form.
|Step 1: Total wage ……………………..$1,000
Step 2: One Allowance ……………….$73.08
Step 3: Allowances claimed…………….4
Step 4: No. of allowances claimed * One allowance………………….$73.08 * 4 = $292.32
Step 5: Amount subject to withholding (Total wage – 292.32)
Step 6: We have to find out the amount to be withheld on $707.68.
Calculation: $16.80 + [($707.68 – $209) * 15/100]
For the above calculation, refer to the IRS Withholding table for Weekly Payroll Period (Single Person) given below
Income Tax Withholding – Weekly Payroll Period (Single Person)
|Over||But Less than||Amount of Income Tax to Withhold|
|$156||$490||$0.00 + (10% of the excess over $156)|
|$490||$1,515||$33.40 + (15% of the excess over $490)|
|$1,515||$2,900||$187.15 + (25% of the excess over $1,515)|
|$2,900||$4,338||$533.40 + (28% of the excess over $2,900)|
|$4,338||$7,624||$936.04 + (33% of the excess over $4,338)|
|$7,624||and above||$2,020.42 + (35% of the excess over $7,624))|
You can use tax calculators as well, to complete the process quickly, or hand over the work to a chartered accountant if the calculation seems complicated. While performing the calculations, you can also consider appointing a tax lawyer or attorney. For additional information, please refer to the IRS website.