As an employer in the United States, you are required to make certain deductions from employees’ income. Deductions can be mandatory or voluntary. Mandatory deductions are those that a legal entity requires you to make; voluntary deductions are those that you offer and the employee consents to. Since mandatory deductions are legally required, you must perform the deductions according to the respective agency’s requirements.
The Internal Revenue Service requires you to withhold federal income tax from employees’ pay. Further, the Federal Insurance Contributions Act (FICA) mandates the collection of Social Security and Medicare taxes. You must withhold these three taxes from employees’ income, unless the employee is exempt, which doesn’t happen often.
Federal Income Tax Calculation
To determine the amount of federal income tax to withhold from an employee’s paycheck, consult the employee’s W-4 form and IRS Circular E for the appropriate tax year. Specifically, obtain the employee’s filing status and number of allowances from lines 3 and 5 of the W-4 then find the tax table in the Circular E that matches that information plus the employee’s wages and pay period; the tax table gives you the exact amount to withhold based on this information. This method of withholding is called the wage bracket method.
Check line 6 of the W-4 to see if the employee opted for additional income tax withholding. If so, add the elected amount to the amount you obtained from the Circular E to arrive at the total withholding. If the employee claims more than 10 allowances or if her wages exceed the wage bracket limit, figure out the withholding by using the percentage method as explained in the Circular E. In most cases, the wage bracket method applies; therefore, it is unlikely that you’ll be required to use the percentage method. If an employee qualifies for – and claims – exempt on line 7 of the W-4, do not withhold any federal income tax from her paychecks.
Consult IRS Circular E or the Social Security Administration’s website for Medicare and Social Security withholding rates for the respective year. For example, in 2012, calculate Social Security tax at 4.2 percent on wages paid before March 1, and at 6.2 percent on wages paid after February 29. The annual wage limit for Social Security in 2012 is $110,100; therefore, once an employee earns that amount for the year, stop the withholding. In 2012, the Medicare withholding rate is 1.45 percent on all wages paid.
Most employees are not exempt from FICA taxes; however, on occasion, an employee is excluded. For example, a student employed by a college or university where she’s pursuing a course of study is exempt from Medicare and Social Security taxes.
Nine states do not require state income tax withholding: Alaska, Florida, Nevada, Wyoming, Washington, Texas, Tennessee, South Dakota and New Hampshire. If state taxes apply, the requirements vary by state. For instance, in California, employers are required to withhold personal income tax and state disability insurance. In Ohio, employers must withhold state income tax, plus school district tax from employees who live in a school district that has imposed an income tax. In Pennsylvania, employers must withhold personal income tax and state unemployment tax. Since state laws differ, consult your state revenue agency for the type of taxes you’re required to withhold.
Calculations for state taxes also vary by state; therefore, use the withholding method that the respective agency requires. For example, in Pennsylvania, employers withhold personal income tax at a flat rate. In California, employers use the state withholding tax tables and the employee’s state tax form (comparable to Form W-4) to figure state income tax.
A wage garnishment is a mandatory deduction. Contact the issuing agency if you have questions concerning a wage garnishment and do not withhold more than the legal amount allowed. Federal law restricts garnishment withholding in a single pay period to the lesser of the amount by which the employee’s disposable pay exceeds 30 times the federal minimum wage or 25 percent of disposable income, which is the employee’s pay after other legally required deductions. The state may require a lesser amount; if so, apply the smaller amount.