How to calculate taxes withheld from a paycheck

The law requires employers to withhold income taxes from employees’ paychecks. The tax withheld depends on the type of tax. The employee can generally control federal income tax withholding because it is largely based on his filing status, income and number of allowances. However, the government sets the Social Security and Medicare tax amounts. Figuring payroll taxes can be confusing, but once the process is understood, the withholding can be determined.

Federal Income Taxes on a Paycheck

Use Form W-4 and the IRS withholding tax tables to determine federal income tax withholding. The filing status and number of allowances from are on the W-4. Then, use the withholding tax tables (Circular E) for the appropriate tax year to perform the calculation. If the employee has 10 or fewer allowances and his income is within the wage limit, he should use the wage bracket method. If he has more than 10 allowances and/or his wages exceed the wage bracket limit, he should use the percentage method.

For the wage bracket method, use the table appropriate to the payroll period and marital status. For instance, if the employee claims single-1 and he is paid $280 weekly in 2010, his federal income tax withholding is $11.

For the percentage method, multiply each allowance for the pay period based on the percentage method table (see page 37 of 2010 Circular E) by the number of allowances he has claimed. Subtract the total from the income. Then, use the appropriate withholding table–page 39 or 40 of the 2010 Circular E–to figure the tax.

State Income Taxes on a Paycheck

Determine state/city/county income tax. Nine states do not charge state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Tennessee, Washington and Wyoming. States such as New York allow cities such as New York City to impose city income tax, and states such as Indiana allow county income taxes. If state tax is applicable, the employer should have given the employee a state tax form to complete. He can get the employee’s filing status and number of allowances from this form. Then, use the withholding tax tables for the appropriate state to determine the state tax.

For instance, the employee’s state is Georgia; he earns $800 biweekly; and he claimed single-0. Based on the Georgia withholding tax tables for 2010, his state tax is $36.64. Note that each table has an income limit. If he surpasses this maximum, he must add 6 percent to amounts exceeding the limit.

State taxes vary. For this reason, the employer must use the guidelines pertaining to his individual state.

FICA Income Taxes on a Paycheck

Calculate Federal Insurance Contributions Act (FICA) tax. FICA is generally listed on the pay stub as Social Security (or OASDI) and Medicare. The government sets the yearly FICA tax percentage and limit. For 2010, the Social Security tax is 6.2 percent of gross wages, up to the annual limit of $106,800. Once the employee reaches this limit, all Social Security withholding should cease until the start of the next year.

Say the employee’s income is $520 biweekly. Calculate Social Security tax as follows: $520 x .062 percent = $32.24.

For 2010, the Medicare tax is 1.45 percent of all gross wages. Using the above example, calculate Medicare tax as follows: $520 x .0145 percent = $7.54.

Final Calculation of Taxes on a Paycheck
Subtract withholding taxes, other statutory deductions such as garnishment or child support, and voluntary deductions such as medical and retirement benefits from the gross pay. The total is the net pay.

Pre-tax and After Tax Payroll Deductions

In addition to payroll taxes, employers can deduct additional amounts from a paycheck as a convenience to employees, or from a government mandate. Accounting for these transactions requires setting up liability accounts.

Example of Payroll Withholding

In addition to payroll taxes, other deductions can be withheld from an employee’s paycheck. These withholdings are generally at the discretion of either the employer or the employee.

The following is an example of deductions from an employee who makes $1,000 in a week:

Payroll taxes of $200, Union dues of $20, credit union of $100, 401K (retirement) contribution of $100, employee portion of health insurance of $50, garnishments of $30. All these deductions result in a net pay to the employee of $500.

The accounting for this entry is:

Debit Payroll Expense $1000
Credit Accrued Union Dues Payable $20
Credit Accrued Credit Union Payable $100
Credit Accrued Retirement Payable $100
Credit Employee Health Insurance Payable $50
Credit Garnishments Payable $30
Credit Accrued Payroll $500

It is important that all the deductions are included or the entry will be out of balance. The Liability accounts will all eventually be debited so that they return to a zero balance. Accrued Payroll will be debited when the employee is paid.

The other accounts will be debited when funds are remitted to the appropriate payee. It is important to note that none of the Payable accounts result in any additional expense to the employer. All of the expense occurs as a result of the payroll entry. A change in garnishments or credit union deductions does not impact the company’s expenses. Each of these is a pass-through payment.

Impact of Before Tax and After Tax Withholding

A deduction can be considered before tax or after tax. The entries are the same for either type, but there is a difference in the amount of tax that is deducted and the resulting employee’s net pay.

Consider an employee who makes $1,000 and has 15% of his salary deducted for income taxes. For the first example the employee is only having income taxes and an after tax $100 credit union deduction. A simple calculation shows his taxes of $150 and net pay of $750.

If the employee changes his deduction from the after tax credit union deduction to a before tax 401K deduction, it changes the amount of tax that is withheld. For tax purposes, the $100 is deducted from his pay before the tax is calculated, and the tax is calculated only on $900. This results in a deduction of only $135, which, along with his 401K deduction, results in a net pay of $765. By changing this withholding to a before tax deduction, the employee has more take home pay.