Small Business Brief


Federal Withholding Tables: How to Properly Calculate Taxes

2018 tax returns are a big national news story right now. This is the first return season since passage of the Tax Cuts and Job Act (TCJA). The Trump administration and Congress passed the TCJA in late 2017 and promised significant tax relief.

At first, there was widespread concern that tax refunds were down. However, the Department of Treasury is now reporting tax refunds of $126 billion back to American taxpayers. This represents a 1.3 percent increase from the year prior.

The reason that tax refunds are down for some is a change to federal withholding tables due to the TCJA. Read on to learn more about how federal withholding tables work for income taxes and other payroll taxes. Explore this comprehensive guide on payroll taxes and how to properly calculate them.

What Are Payroll Taxes?

Payroll taxes are applied to employee wages and self-employment income. The federal government collects these taxes to pay for supplies and services.

There are many different payroll taxes to walk through. It is important to know that while income taxes are deducted from an employee’s pay, they are not technically considered a payroll tax.

Instead, the Internal Revenue Service (IRS) categorizes them as other federal taxes. Individual and corporate income taxes make up the lion’s share of federal tax collections.

FICA Taxes

The most impactful payroll taxes are referred to as Federal Insurance Contribution Act (FICA) taxes. The two primary FICA taxes cover Social Security and Medicare. These are entitlements that provide income and health care in retirement to American citizens.

Unemployment Taxes

Another common payroll tax is called the Federal Unemployment Tax Act (FUTA). This tax is designed to provide unemployment benefits for Americans who lose their job. Depending on what state you live in, there may be additional unemployment taxes applied.

Self-Employment Taxes

These 3 payroll taxes cover employees who receive a W-2 and are paid traditional wages. For independent contractors and freelancers, payroll taxes work differently. Instead, they pay a self-employment tax mandated by the Self Employment Contributions Act (SECA).

What Are the Politics Behind Payroll Taxes?

Payroll taxes are a controversial topic in political circles. The reason is they disproportionately affect low-income earners. Because of this fact, economists consider payroll taxes to be regressive in nature.

According to studies on government data, low-income workers contribute nearly 7 percent of their total income to payroll taxes. On the other hand, the top 1 percent pay just 2.3 percent of their income towards payroll taxes. That being said, the TCJA legislation passed by the U.S. government did not adjust payroll tax rates.

What Are the Payroll Tax Rates?

Each payroll tax has a different tax rate and limits on its application. For example, the Social Security tax rate is 6.2 percent of gross pay. The Medicare tax rate, on the other hand, is 1.45 percent of gross pay.

The tax rate described above applies to the employee only. The employer is responsible for contributing an equal amount to the Treasury Department as the individual.

For both Social Security and Medicare, there are income thresholds that trigger calculation changes. Social Security, for instance, has a hard cap of $132,900 in 2018 dollars. When an employee hits this threshold, they stop contributing to the Treasury Department for the remainder of the year.

Medicare’s threshold is $200,000 for individuals and $250,000 for married couples filing jointly. Wages above this threshold are taxed at an additional 0.9 percentage points. This new tax revenue for the Treasury Department is used to fund Medicare’s hospital insurance.

What Is a W-4 Form?

Now that we have covered payroll taxes, it is time to account for the federal income tax. This is the most significant deduction to an employee’s paycheck.

The process begins with an IRS form called the W-4. Your employer should provide you with a W-4 form when you begin work for the company. Note, the W-4 form is provided to traditional employees and not given to independent contractors or freelance workers.

The W-4 form provides the Treasury Department with a basis for federal income tax withholdings. The form asks you general questions about your filing status. The form asks about the number of tax allowances, dependents, or your marital status. If you want to avoid owing Uncle Sam at the end of the tax season, you can ask for additional wages to be withheld.

The W-4 form is not set in stone. You can request an update at any time. For example, if you have a new child it may be time to update the W-4.

What Are Federal Withholding Tables?

Federal withholding tables are released by the IRS to show how much the federal government deducts from an employee’s pay. For the 2019 tax season, the IRS released Notice 1036. This notice provides employers with the withholding rates for federal income taxes.

You will find more info for performing the withholding calculation on IRS Publication 15-A. There are a few things you need to know before calculating.

First, you need to know how frequently the employee is paid. Employees are commonly paid on a weekly or biweekly basis.

You also need to know if the employee is married and how many tax allowances they claimed on the W-4 form. Also, take note of whether the employee requested any additional withholdings on the W-4.

The last piece of the equation is the employee’s gross pay. The IRS Publication incorporates the federal withholding tables and allows you to determine the specific withholding amount.

There are two different methods used to arrive at the withholding amount. These tactics are referred to as the wage bracket and percentage methods. If the process seems overwhelming to you, it may be wise to hire an accountant or payroll specialist to minimize the risk of costly errors.

Wrapping It Up

The federal tax withholding system is fairly complex and requires many calculations. In addition to income, taxes are also levied on the employee for Medicare, Social Security, and unemployment.

If you enjoyed this article about the federal withholding tables, check out our small business articles for other great content.