ComplianceLegalFinanceTax & AccountingOctober 25, 2020

Determining which payroll taxes apply to your employees

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Employers face numerous payroll tax responsibilities which include withholding, paying and reporting federal, state and local income tax, Social Security and Medicare, unemployment taxes, and in a few states, disability insurance taxes. Federal income tax withholding requires employers to properly calculate the withholding amount from an employee's compensation, taking into account the employee's withholding exemptions claimed on IRS Form W-4.

If you're an employer with workers who are taxable employees, your payroll tax obligations may vary, but will be comprised of some combination of the following:

  • federal income tax withholding
  • Social Security and Medicare (FICA) taxes
  • federal (FUTA) and state unemployment taxes
  • state, and sometimes local, income taxes
  • state disability insurance taxes

Federal income tax withholding

Whenever you pay wages or other compensation to an employee, you can assume that the IRS will expect you to collect a portion of the employee's federal income tax on the payment through withholding.

  • Calculating the withholding amount. Once you've determined that a given payment is subject to withholding, calculating the amount to withhold is fairly straightforward. Although the law provides specific rules for calculating that amount, the IRS has reduced the rules to simple tax tables that you can use in most cases.
  • Withholding exemptions. Because an employee's tax liability differs depending on his or her marital status, number of dependents, and other factors, each of your employees must fill out a W-4 form that accounts for such differences by allowing the employee to claim one or more withholding exemptions.

Calculating the withholding amount

Your obligation to withhold federal income tax from your employees' wages extends to each separate wage payment that you make. For instance, it's improper for you to pay your employees their gross wages for the first three or four weekly payroll periods in a month with no taxes withheld, and then deduct all taxes for the month from the last paycheck. Each wage payment is a separate and distinct taxable event.

Because the total federal income tax you withhold from a particular employee's wages is supposed to approximate that employee's year-end tax liability, the amount you withhold for each of your employees is likely to be different. The factors affecting how much you must withhold from a given wage payment are:

  • the frequency of your payroll period
  • the employee's marital status
  • the number of withholding exemptions the employee claims
  • the size of the wage payment

While this process may sound complex, you can quickly determine your withholding amounts if you know these factors because the IRS has incorporated the required computations into easy-to-use standard tables.

And if you use payroll software to generate your employees' paychecks, the software will automatically consult the tables and compute the tax to be withheld from each paycheck.

There are two basic types of standard withholding tables: wage-bracket tables and percentage method tables.

Wage-bracket tables. The easiest tables to use are the wage-bracket tables. There are different tables for five types of payroll periods (weekly, biweekly, semimonthly, monthly, and daily/miscellaneous).

Using the applicable table for your payroll period and the employee's marital status, you merely find the wage bracket within which the employee's wages fall, and then read across the table to the column that reflects the number of withholding exemptions the employee has claimed to find how much you must withhold.

Percentage method tables. The percentage method tables are the other commonly used withholding tables. Percentage method tables are available for eight different payroll periods (weekly, biweekly, semimonthly, monthly, quarterly, semiannual, annual, and daily/miscellaneous), and there are separate sets of tables for married and single employees.

Your first step in using these tables is to reduce an employee's wages by the value of the employee's withholding exemptions. Then, using the applicable table for your payroll period and the employee's marital status, you find the wage bracket within which the employee's adjusted wages fall. The withholding tax is shown in the table as a dollar amount plus a percentage of that portion of the wages that exceeds the minimum bracket amount.

Accessing the tables. You can obtain a free copy of the standard tables by calling the IRS at 1-800-TAX-FORM or going online to the IRS website. The tables are available in Publication 15, Circular E, Employer's Tax Guide. Additional tables are included in Publication 15A: Employer's Supplemental Tax Guide.

Alternative withholding methods. Are there other methods that you can use in lieu of using the wage bracket or percentage method tables to determine how much you must withhold? Yes, however, we suggest that you consult with your accountant or other tax professional before attempting to use any of these alternative methods because they are much more complex than the standard withholding tables.

Warning: While you can select the method to determine your withholding taxes, you have no discretion to withhold less than the amount of tax prescribed by that method. Also, as a general rule, you may not withhold more than the prescribed amount, unless an employee requests that you do so.

Claiming payroll tax withholding exemptions for employees

The total federal income tax that you withhold from an employee's wages during the year is supposed to approximate the employee's year-end tax liability.

However, when your employees prepare their annual tax returns, they don't pay tax on their entire gross wages. Rather, they reduce their gross wages (and other income) by personal exemptions for themselves, their spouses, and their dependents and by various deductions in determining the portion of their income that is actually taxable.

To account for these exemptions and deductions in the tax you withhold, your employees are entitled to claim withholding exemptions.

Generally speaking, the more withholding exemptions an employee claims, the less tax you'll be required to withhold. Technically, each withholding exemption frees a specified dollar amount of wages from withholding. For 2013, the annual value of a withholding exemption is $3,900.

In other words, each withholding exemption that an employee claims for 2013 will effectively exempt $3,900 in annual wages from withholding. (For 2014, each withholding exemption is worth $3,950

Federal Form W-4. Your employees claim their withholding exemptions by filing with you federal Form W-4, Employees' Withholding Allowance Certificate.

One of the first things you should do whenever you hire a new employee is to have the employee fill out a W-4. 

If you don't have a valid W-4 on file for an employee, you must treat the employee as being single with no exemptions for withholding purposes.

In the Business Tools area is a federal W-4 form that you can use to collect withholding from your employees.

It's also good practice to remind your employees at the beginning of each year that they should file amended W-4s if their eligibility for claiming withholding exemptions has changed since the filing of their last certificates.

Permissible exemptions. On their W-4, your employees can claim a withholding exemption for themselves, and for a spouse if the spouse is not claiming his or her own exemption on the spouse's W-4. An employee can also claim one exemption for each child or other dependent claimed on his or her tax return.

Employees who expect to claim large amounts of itemized deductions on their return may be entitled to additional withholding exemptions.

Although your employees may not claim more withholding exemptions than they're entitled to, they may claim fewer than they're entitled to. Furthermore, employees can request on their W-4 that you withhold additional dollar amounts from their wages.

This is often necessary if the employee's spouse is employed, since the couple's combined tax liability will usually be higher than the normal withholding formulas provide. It is also an option if the employee will be under-withheld for the 0.9 percent FICA Medicare surtax and does not want to have to make estimated tax payments.

Example: Your employee Theodore is married with three young children. Theodore's spouse is a stay-at-home mom and doesn't expect to earn taxable wages in 2013. Theodore claims a total of five withholding exemptions on his Form W-4; one for his wife, one for him, and one for each of his children.

On the other hand, your newest employee Alvin has a spouse who received her MBA in January 2013 and almost immediately accepted a job offer for a high-paying position. Alvin and his spouse have no children. Although Alvin has two permissible withholding exemptions available (one for him and one for his wife) he claims zero withholding exemptions on his Form W-4, as does his wife. Because Alvin and his wife's combined tax liability will exceed the amount provided for by the withholding formulas, they properly exercised their option to claim fewer exemptions than they're entitled to claim.

No-tax liability exemptions. An employee who anticipates having no federal income tax liability for the year may claim a complete exemption from withholding on Form W-4.

This exemption fully relieves you from any obligation to withhold federal income taxes (but not FICA taxes) from the employee's wages.

To qualify for the exemption, the employee:

  1. must have had no tax liability for the prior year;
  2. cannot be claimed as a dependent on another person's tax return; and
  3. cannot have more than $350 in nonwage income such as interest, unless the employee expects to have a total income of less than $1,000.

The exemption from withholding lasts only up to February 15 of the following year, unless the employee files a new W-4 that renews the exemption claim.

W-4s don't get filed with the IRS. In general, you're under no obligation to confirm that your employees are entitled to each withholding exemption they claim on their W-4s, and you don't have to file the W-4s with the government.

What if you learn that an employee has improperly claimed exemptions? Your obligations change if you have this knowledge. You must:

  • inform the employee that the W-4 is invalid
  • request a new W-4
  • send the invalid W-4 to the IRS
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