How to Calculate Federal Taxes on Wages

The federal income tax withholding system, implemented in 1943, requires employers to withhold federal income tax from employees' wages. The employer calculates the withholding according to the rates the federal government sets. The employer pays federal taxes withheld from wages to the Internal Revenue Service.

Types

• Employers are required to withhold federal income tax from employees' wages. Additionally, Social Security and Medicare taxes are types of payroll taxes that employers withhold from employees' wages. The Federal Insurance Contributions Act is the law the mandates the collection of Social Security and Medicare taxes. These two taxes are often called FICA taxes.

Form

• The IRS requires employers to give new employees a W-4 form, which helps the employer determine the amount of federal income tax to withhold. The employee states her filing status on the form, such as single or married, and her allowances, such as her dependents. Each allowance is worth a certain sum, which reduces taxable wages. The more allowances the employee claims, the less federal income tax she is likely to pay.

  If the employee fails to submit a W-4 form, the employer still withholds the tax, but does so at the highest tax rate of single with no allowances. The employee can claim exempt on the W-4 if she qualifies for it. In this case, she does not pay federal income tax.

Process

• The employer calculates federal income tax withholding according to the IRS Circular E's withholding tax tables and the employee's W-4 data. It uses the tax table relevant to the employee's filing status, allowances, pay period and gross wages. Gross wages is the employee's pay before deductions occur. If the employee has a voluntary pretax deduction, such as a flexible spending account or a traditional 401k plan, the employer deducts the benefit before withholding federal taxes.

Methods

• The employer can use the Circular E's wage bracket method to figure the withholding tax if the employee's wages are within the wage bracket's income limit and if he claims fewer than 10 allowances. This method gives the exact amount to withhold based on the W-4 data.

  The employer can use the percentage method whenever it wants. The IRS gives the employee a certain sum for each allowance he claims on his W-4 form. When using the percentage method, the employer uses the Circular E to determine the total allowances amount. According to page 37 of the 2010 Circular E, the IRS gives $70.19 per allowance for a weekly payroll. Therefore, two allowances for a biweekly payroll is $280.76 ($70.19 x 2 weeks x 2 allowances at $70.19 each). To arrive at the wages subject to taxation, the employer subtracts the total allowances amount from the employee's gross income. Then, it uses the Circular E's percentage method table specific to the employee's pay period, filing status and taxable wages to figure the withholding amount.

FICA Calculation

• The employer computes Social Security tax at 6.2 percent of gross wages, up to the yearly wage base of $106,800. Medicare tax is deducted from all wages at the rate of 1.45 percent. Notably, both the employer and the employee pay equal amounts of FICA taxes.

Considerations

• The employer gives the employee an annual W2 form showing wages paid and taxes withheld for the year. The employer files the W2 with the Social Security Administration, and gives the employee a copy to file her tax return.