How to Calculate Withholding Tax
When it comes to federal income tax , many taxpayers may have questions about the way tax withholding works. How you fill out your Form W-4 will determine much of what comes out of your salary each pay period to be submitted to the Internal Revenue Service ( IRS ). Established federal income tax rates currently fall into seven percentages as of 2021. These rates exist independent of any taxes you may owe at the state level.
Federal income tax impacts everyone, but it's particularly important for small business owners to understand how to complete this vital accounting step correctly. Employers typically hold taxes back from each employee pay period so employees can claim a tax credit on their tax returns for the amounts withheld.
If you work for yourself, own your own company, or primarily freelance, you are generally responsible for calculating your own withholdings. This article will delve into important details regarding how to calculate withholding tax and offer tips to avoid confusion in this important financial matter.
What Is Federal Income Tax?
Federal income tax refers to the amount of taxes an employer must withhold and pay to the IRS . This figure is based largely on a worker's gross income earned in the form of wages for the year. However, pre- tax deductions may affect this number, as pre-tax items are excluded from calculations of gross income .
If you have items such as retirement plan contributions, health savings account (HSA) contributions, life insurance, Medicare tax , or Social Security tax due during a payroll period , these all qualify as pre- tax deductions . Check out the full pre- tax deduction list to see what else in your financial portfolio might fall into this category.
The Federal Insurance Contributions Act (FICA) put into place flat-rate payroll taxes for the two major federal taxes affecting gross pay : Social Security and Medicare. Social Security tax is held back at a rate of 6.2% on all gross earnings after the subtraction of any pre-tax exemptions . Medicare will take 1.45% of your gross wages . However, an additional 0.9% is added to the Medicare tax for higher-income earners.
Employees misclassified as independent contractors fall into a special category regarding federal income tax withholdings because Social Security and Medicare taxes were not withheld from their earnings, although they should have been. In this case, they can use Form 8919 to figure in these FICA tax deductions on their annual tax return .
What Is the Percentage of Federal Tax Withheld?
At present, there are seven federal income tax rates : 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The amount of tax withholding that impacts you will depend on multiple factors, such as your gross income from wages and your tax filing status . The following are filing status options:
- Single: For those who are unmarried on the final day of the tax year
- Head of Household : For single taxpayers who have at least one dependent child
- Qualifying Widow or Widower With Dependent Children: For those who have lost a spouse more than one tax year ago, have at least one dependent child, and would like to keep enjoying the same federal tax rates as married couples filing jointly
- Married Filing Jointly: For couples who wish to report all incomes and deductions earned by each individual together as one figure (comes with more federal tax benefits)
- Married Filing Separately: For couples who wish to keep individual tax liabilities /finances separate for any number of reasons
Which option you choose from the list above, coupled with your wage bracket, will determine which of the seven federal tax rate categories apply to your specific payroll taxes . We'll show you how to find the income tax rate that affects you and how to calculate your income tax withholding below. Keep in mind that it's always advisable to consult with a tax professional to ensure that your tax interests are being addressed in the manner most advantageous to you.
How to Calculate Income Tax Withholding?
You'll need to complete a few steps before you begin calculating withholding tax. Review the income tax withholding tables provided by the Internal Revenue Service in Publication 15-A of the Employer's Tax Guide to help you calculate how much should be kept back from a given employee's (or your own) salary.
Use this IRS publication to determine income tax brackets , taxable income , and other additional taxes that may need to come out of an employee's paycheck . Also, gather relevant information ahead of time from Form W-4 . One key item to note is that withholding allowances are no longer a part of the new Form W-4 as of 2020.
Tax rates and brackets relate to filing status , which will be discussed in further detail below. Essentially, the amount of income tax withholding will correspond directly to the amount of money earned through wages and the specific way that the taxpayer chooses to file taxes (e.g., married, divorced, or head of household ). Follow the next steps for calculating withholding tax.
1. Gather Relevant Information
The all-important IRS Form W-4 contains much of the pertinent information you will need for your withholding calculations. This is where you will find the employment tax filing status , Social Security number, name, address, and any additional income that might have been earned from side jobs for the taxpayer in question.
It's wise to keep the management of different work invoices under control with Skynova's accounting software so side income doesn't get lost in the shuffle throughout the year.
2. Use a W-4 Form
As mentioned, the IRS rolled out a revised W-4 in 2020 that no longer includes withholding allowances . The good news is that this new version of the W-4 does much of the work for you and eliminates a great deal of the guesswork associated with tax payments by automatically providing the correct amount to be withheld from your pay based on your responses to each section. W-4 forms may be filed in paper or electronic formats.
3. Adjust Tax Withholdings as Needed
Further good news about the new W-4 is that you can always change your answers if needed. You aren't stuck with your original tax withholding calculation and may need to make adjustments based on life or financial changes that occur. Adjust your IRS withholding figures any time one of the following events impacts you:
- You get married, divorced, experience the death of a spouse, or the birth/adoption of a child
- You or your spouse gains or loses a secondary source of income
- You qualify for fewer — or more — tax deductions , credits, or adjustments to income
Freelancers and consultants may have concerns about being able to keep up with the ebb and flow of their income throughout the fiscal year. Remove worry and doubt by making use of Skynova's software products, which allow you to manage the projects you complete for as many different clients or customers as needed.
Stay Organized With Skynova
One of the best ways to stay organized with your taxes is to keep track of your income. With Skynova's software and business templates, small business owners and freelancers alike can manage and organize their income with ease.
From streamlining recurring invoices to handling customer credit notes or retainers, Skynova has your small business covered. Check out Skynova today for accounting software that can simplify the process of getting paid and staying organized so tax season will be a breeze.