When it comes to running a business, you need to be aware of many payroll factors. Setting up payroll can be a difficult process. You need to obtain an Employer Identification Number (EIN), collect important paperwork, establish a pay period, and choose a payroll system. But in addition to setting up payroll for your employees, you also have to understand federal withholding tax tables. Withholding tables are important for business owners to understand because they need to calculate how much tax to withhold from employee paychecks.
Not calculating federal withholding tax correctly can result in many issues for your business. An employer has legal responsibility to withhold payroll taxes and pay those taxes to the Internal Revenue Service (IRS). Not doing so will impact both the employer and the employee and can even lead to more serious consequences, like having to pay a heavy fine. So it is crucial you stay on top of these taxes.
Understanding what a federal withholding tax table is will take some time, so let’s break it down into key components. Read the post in full or navigate using the links below to jump ahead:
- What are income tax withholding tables?
- Federal withholding term definitions
- How to calculate withholding tax
- 2021 income tax withholding tables
- What is the income tax rate for 2021?
- How to use a tax withholding table
What are income tax withholding tables?
Federal withholding tables dictate how much money an employer should withhold from their employees’ wages. This includes federal income tax, Social Security and Medicare tax, and sometimes state income tax as well. A federal withholding tax table is usually in the form of a table or chart to simplify this process for employers. To determine the amount to withhold, you will need an employee’s W-4 information, filing status, and pay frequency. Every new employee at a business needs to fill out a W-4 for this purpose.
Form W-4, Employee’s Withholding Certificate, is a tax form issued by the IRS that all U.S. employees must complete. These are the components of 2020 or later Form W-4:
- Personal information
Multiple jobs or spouse works
- Multiple jobs worksheet
- Claim dependents
Other adjustments (optional)
- Deductions worksheet
Federal withholding term definitions
Before we get into calculations, let’s define a couple of key terms related to federal withholding tax tables:
Gross pay: The full amount of your salary before deductions, withholdings, and contributions are taken out of it
Net pay: Your take-home pay, once deductions, withholdings, and contributions are removed from your gross pay
Withholdings: The amount taken out of an employee’s paycheck to pay their income taxes during that pay period
Deductions: The amount taken out of an employee’s paycheck to pay for specific benefits/donations the employee has chosen, such as retirement or health care
These are all common terms that have to do with withholding tax, so it is important to understand these definitions as an employer.
How to calculate withholding tax
So now that you understand what a federal withholding tax table is, let’s discuss how to calculate withholding tax. Follow the steps below to calculate federal withholding tax rate:
1. Collect required documents
Gathering all relevant documents from your employees is the first step in correctly calculating withholding tax. To calculate withholding tax, you’ll need your employee’s W-4 form, gross pay for the pay period, and an income withholding tax table.
2. Reference employee W-4s
It is crucial that your employee fills out their W-4 correctly for your withholding tax calculations. Your employee will have to fill out their filing status, number of dependents, additional income information, and any other amounts the employee requests to be withheld. You will need to reference this form to calculate withholding tax.
3. Review payroll records
To calculate employee withholding tax, you will need to review important information from your payroll. An employer will need to look at the payroll period details, the frequency of the pay periods, and the gross pay amount for the pay period.
An employer is also responsible for payroll withholding, which is money taken out of an employee’s gross wages. The money taken out is then used to pay their portion of payroll taxes on their behalf. There are also payroll deductions, which is money taken out of an employee’s paycheck that goes toward paying for costs like payroll and income taxes, employee benefits, and more. Payroll deductions can either be mandatory, which employers are required to pay, or voluntary, which employees have the option to pay.
Understanding payroll can be overwhelming, which is why it is useful to use a payroll accounting service to keep track of payroll costs and employee compensation.
4. Calculate withholding tax
There are two federal income tax withholding methods for use in 2021: wage bracket method and percentage method.
- Wage bracket method: This is the simpler method, and it tells you the exact amount of money to withhold based on an employee’s taxable wages, number of allowances, marital status, and payroll period. It does not involve any calculations to determine federal withholding tax.
- Percentage method: This method is a bit more complex as it involves more calculations. It differs in that it has no wage or allowance limits. You can use this method if your employee’s wage exceeds the wage bracket limit or they have 10 or more allowances. If you use an automated payroll system, it will use the percentage method.
2021 income tax withholding tables
2021 federal withholding tables are a bit different than they used to be. The IRS adjusts income threshold every year for inflation. That means the federal income withholding tables change every year, in addition to the tax brackets. These are the 2021 withholding tax table updates:
- Changes in tax rates and brackets
- New computational bridge for 2019 or earlier W-4s
- No withholding allowances on 2020 and later W-4s
- No personal exemptions still in effect
- Supplemental tax rate remains 22%
- Backup withholding rate remains 24%
There are also rate and bracket updates to the 2021 income tax withholding tables. The federal withholding tax table that you use will depend on the type of W-4 your employees filled out and whether you automate payroll. Employers have the option to use a computational bridge to treat 2019 or earlier W-4s as if they were 2020 or later W-4s, specifically for tax withholding purposes. If your employees filled out a 2020 or later W-4, it is important to note that they can no longer request adjustments to their withholding allowances. Instead, there is a “standard withholding” and a “Form W-4, Step 2, Checkbox withholding” section.
If you’re unsure of which federal withholding tax table to use for an employee, here is an overview:
- Automated payroll systems use percentage method tables
- 2020 or later W-4s use wage bracket method tables
- 2019 or earlier W-4s use wage bracket method tables
- 2020 or later W-4s use percentage method tables
- 2019 or earlier W-4s use percentage method tables
Withholding allowances were also removed in 2020 or later W-4s. Before withholding allowances were removed, employees could claim more allowances to decrease their federal income tax withholding. But now, on updated W-4s, employees can only lower their tax withholding by claiming dependents or by using the deduction worksheet on the form.
What is the income tax rate for 2021?
The federal withholding tax has seven rates for 2021: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The federal withholding tax rate an employee owes depends on their income level and filing status. This all depends on whether you’re filing as single, married jointly or married separately, or head of household.
How to use a withholding tax table
So now that you understand what a withholding tax table is and how to calculate withholding tax, let’s talk about how to use a withholding tax table. It’s relatively simple when you break it down into four key steps:
- Adjust the employee’s wage amount
- Figure out the tentative withholding amount
- Account for tax credits
- Figure the final amount to withhold
Understanding federal withholding tax tables is undeniably difficult. There are a lot of components to understand, but it is important to learn for the sake of your business and your employees. Correctly calculating withholding tax is crucial for many reasons. To run a business efficiently and pay your employees accurately, you need to make sure they fill out their W-4s correctly. Not doing so can put you, your business, and your employees in deep water.
Starting your own business means having to take on a myriad of new responsibilities, so it is helpful to understand tax basics as a new business owner. Using a service like QuickBooks Payroll to handle calculations can simplify your life as a business owner. QuickBooks Payroll offers everything from HR support to a paycheck calculator, so you can spend less time focusing on payroll and more time running your business. Understanding federal withholding tax is challenging, but using a payroll service like QuickBooks payroll will take a weight off your shoulders so you can be confident you’re not missing any steps when it comes to filing taxes for your business.
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