How to Calculate Withholding Tax: A Simple Payroll Guide for Small Business

Small businesses require calculating the withholding tax on how much money they should deduct from employees’ paycheck to send the amount to IRS to cover taxes. The government sets the tax rate for businesses to deduct the amount from employee salary and wages according to employee’s Form W-4. There are two main methods to be used by businesses for calculating withholding tax that are:

  • Percentage method
  • Wage bracket method

To calculate withholding tax correctly, the business requires employee information in terms of its W-4 form, each employee’s gross pay for the pay period, and IRS withholding tax tables and tax calculation for the current accounting year. For carrying out the calculations the small business owner should know how to find the correct tax rate.

calculating withholding tax

These topics take you through how to calculate withholding tax:

How to calculate Withholding Tax?

Once the employee has filled the form W-4, the employer can quickly get information and calculate withholding tax. With the help of withholding tables given by IRS, start calculations with the following steps:

  • Gather relevant documents:

Gather all the relevant documentation that will help you calculate the withholding tax, such as, employee’s W-4 form, withholding tables, and IRS worksheet.

  • Review the employee’s W-4 forms:

Review the employee’s relevant information for calculating withholding tax, such as their filing status, dependents number, any additional income information, or any other amount that the employee wants to be withheld.

  • Review payroll details:

Review the payroll details that are relevant to the withholding tax calculations. The information required by the employer includes payroll period details, frequency of pay period, the gross pay amount for the pay period (salary and wages).

  • Choose your calculation method:

Once you have gathered the above documents and information related to the withholding tax calculations then you have to choose a method for calculation. There are two methods:

  1. The wage bracket method:

This method is the simplest one and easy to calculate. You can use the tables given by the IRS for withholding tax for figuring out each employee’s wage range.

  1. The percentage method:

The percentage method is more complex and instructions are also included in IRS Publication 15-T. The instructions are different based on whether you use an automated payroll system or a manual payroll system. The worksheet walks you through the calculation, including determining the employee’s wage amount, accounting for tax credits, and calculating the final amount to withhold.

What are the Withholding Allowances?

Withholding allowances were used by employees to get some exemption in withholding taxes. Withholding allowance was used to find the withholding tax amount on an employee’s paycheck. 

Withholding allowances are no longer used on the 2020 W-4 form and onwards.

What Is the Income Tax Rate for 2021?

The federal income tax has seven tax rates for 2021: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. The amount of federal income tax an employee owes depends on their income level and filing status, for example, whether they’re single or married, or the head of a household. 

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