Payroll deduction can be voluntary or statutory. If the employer offers the deduction, such as a 401(k) or medical plan, and the employee consents to it, the deduction is voluntary. If a federal or state government requires the deduction, it is statutory. Consequently, federal withholding, which requires the employer to withhold federal payroll taxes from employees' paychecks is a statutory deduction. The employer calculates federal withholding according to the rules the Internal Revenue Service administers.
Withholding Form
Federal income tax (FIT) withholding depends on the withholding conditions the employee states on her W-4 form and IRS Circular E's withholding tax tables. The IRS requires all employers to provide each new employee with a W-4. The employee includes her filing status and allowances on the form, which are necessary to figure federal income tax withholding. The employee can also include extra tax to be withheld from each paycheck or claim exempt from federal income tax on the form. Federal income tax applies to all employees unless an exemption applies; therefore, if the employee fails to submit a W-4, the IRS requires the employer to withhold at single with zero allowances.
FIT Calculation
The employer uses the Circular E withholding tax table that applies to the employee's allowances, filing status, earnings and pay period to determine federal income tax. It can use the wage bracket method to figure the exact withholding amount if the employee's income is within the wage bracket's income range and if he claims less than 10 allowances. If he claims more than 10 allowances, or if his income exceeds the wage bracket limit, the employer can use the percentage method. In this case, the employer uses the Circular E's allowance table (see page 37 of the 2010 version) to figure the amount for each allowance. It subtracts the total allowances sum from the employee's gross earnings to arrive at her taxable income. It applies the percentage method table relevant to the employee's taxable income, pay period and filing status to figure the withholding amount.
FICA Calculation
Social Security tax -- also called OASDI -- and Medicare tax are federal payroll taxes that the Federal Insurance Contributions Act authorizes. The employer withholds Social Security tax at 6.2 percent of gross compensation up to $106,800 for the year and withholds Medicare tax at 1.45 percent of all gross compensation. The employer pays a matching portions of these taxes.
Considerations
To eliminate manual calculation and possible errors, the employer can use payroll software to figure federal withholding amounts. The software has the tax tables and FICA rates embedded in the system. The employer reports and pays all federal withholding to the IRS. It files W-2s annually with the Social Security Administration, showing each employee's wages paid and taxes withheld for the year.
