One of the most time-consuming tasks a business accounting office has is processing payroll. Within that task, the payroll clerk must accurately estimate all payroll deductions for each employee.
Every employee of a business pays income tax based on earned income, whether on hourly wage or salaried position. The initial income figure comprises all wages, commissions, tips and other taxable compensation paid to the employee for the pay period; that total is called “gross income.” The maximum amount of income tax each individual owes is based on the gross annual wage and compensation figure on the W-2 form minus authorized deductions; only gross income estimates are withheld each pay period.
Do not include reimbursement for authorized business expenses.
Tips are calculated at the larger amount between the declared rate and the IRS-determined minimum as outlined in the IRS’ Publication 15, Circular E. (See SOURCES, below, for link.)
Fringe benefits can also be taxed as compensation in many circumstances. For specific information, see Treasury Decision 9276, 2006-37 I.R.B. 423.
The Federal Insurance Contributions Act or FICA taxes are paid at 7.65% of gross income and divided into two parts. Social Security Benefits receive 6.2% of FICA funds, and Medicare receives the remaining 1.45%. Social Security deductions reach an annual limit of $6,621.60 in contributions, while the Medicare portion of FICA has no limit.
W-4 Form Information
Obtain the filing status and withholding amount listed on the employee’s W-4 Form. If none was completed and submitted, use a “single” filing status and $0 withholding allowance. IRS Publication E annotates the amount to be withheld, which can vary depending on pay period length and filing status. The longer the pay period for Single status, the more is withheld.
Compute Total Taxes Withheld
Using Publication 15, multiply the withholding allowance number by the amount noted in the IRS publication and then subtract the amount from the gross income figure for the employee. The amount remaining is the taxable income.
Next, compute the federal tax to be withheld. Using the percentage tables in Publication 15, find the applicable filing status noted on the W-4. The withholding amount is determined by percentages that increase as income increases. The income up to the hypothetical $150 is taxed at 10%; the next hypothetical limit is taxed at a higher rate. The next gradient is taxed slightly more, etc., until the entire income amount is accommodated. Add each gradient amount into a tax withholding total and note in the payroll records.
Department of the Treasury, Internal Revenue Service, Treasury Decision 9276, 2006-37 I.R.B. 423, found at: http://www.irs.gov/irb/2006-37_IRB/ar09.html
Department of the Treasury, IRS, “Employer’s Tax Guide”, Publication 15, Circular E; Cat. No. 10000W.
IRS, publication 501 (2009), Exemptions, Standard Deduction, and Filing Information, found at: http://www.irs.gov/publications/p501/index.html
John Wiley & Sons, Inc. “Payroll Best Practices,” (c) 2005, by Steven M. Bragg.