how does payroll withholding help a company's employees?
While one benefit of this system is more consistent tax collecting for the federal government, another benefit is that employees have their tax obligation simplified and of less daily concern. Accomplishing the labor of fulfilling this legal requirement for your employee can be seen as one of the “perks” your employees get in return for working for your business.
Because part of retaining a happy workforce involves withholding proper amounts of their tax payment, this article will focus on helping you learn how withholding works and how to accomplish it correctly. Accurate withholding will allow you and your employees to worry less and spend more time developing your business.
What is payroll withholding and how does it work?
Payroll withholding takes a specific portion of an employee's gross pay and pays it to a larger governmental body. The specific percentage withheld is dependent on various factors and varies from employee to employee. Tax documents like W-4s and W-9s help determine what these factors are and what that specific percent will be, which can change throughout an individual's life.
The governmental body the taxes are paid to is primarily the federal government. There are also state taxes that vary in amount depending on the specific state, and there can also be local taxes as well, but many of those take the shape of sales tax rather than payroll withholding. More on that later!
With the process briefly summarized, let’s discuss specifics and what you need to know to fulfill payroll withholding properly.
Net pay: Net pay is the final amount your employees receive after all withholding has been enacted. This term is usually seen paired or opposed with “gross pay,” which is the amount initially due to your employee before any withholdings take place. It’s also commonly called “take-home” pay.
Because of the many factors that vary how much an employee might have withheld, most (if not all) employers choose to present new hires with gross pay offers. They have tax withholdings as an underlying assumption between both parties. After all, the gross pay is truly the amount you’re paying them for their work, even if they don’t receive all of it in the end.
What is a W-4 and how does it work?
W-4s are a legal requirement for workers designated as “employees”, and are typically one of the first things exchanged upon hire. W-4s collect all relevant employee tax information. This data allows you to calculate what percentage of an employee’s gross pay needs to be withheld.
W-4s provide the following pertinent tax information:
- Filing status (marriage status/family situation)
- Number of held jobs
- Allowances (number of dependents)
You can either print out W-4 forms from the official Internal Revenue Service's website or have your employees email digital versions to you.
After you have them, you’ll use the tallying system on the W-4 to determine the total taxable earnings. Then, you’ll be able to use the IRS’s income tax withholding table to calculate the amount you should withhold to pay as the federal income tax.
Difference between state and federal withholding: As mentioned previously, each state will have their own state income tax that you’re also responsible for withholding from your employees. Unlike the federal income tax, these percentage rates are much easier to find, though it’s important to stay up-to-date as they can change. Though it’s rare, there are a few states without state tax and instead, have increased sales tax as its replacement.
Once you’ve looked up your state's tax rate, multiply this by the taxable income the employee’s W-4 provided you.
Both Social Security and Medicare work the same as state tax; multiply the taxable earnings by their rates to calculate your withholdings for each respective tax. (Currently, Social Security’s tax rate is 6.2% and Medicare’s is 1.45%)
Aside from calculation differences, state and federal differ mainly in which governing body the withholding will help fund.
Determining your taxes as the employer: As an employer, you must also pay taxes, and you do this by matching the tax withholdings you calculate until base wages are surpassed. There are federal, state, and social security base wages. These base wages change often, so you’ll have to stay aware of any changes. Medicare is paid throughout the year regardless, and has no base wage.
For example, suppose the base wage for federal tax this year is $97,000. You’ll calculate your employee’s withholdings, match that withholding, and continue to do so until the employee surpasses $97,000 in gross pay for the year, in which case, the employee will no longer owe any more federal tax. You’ll no longer need to match them until the following calendar year.
What payroll withholding deductions are you required to oversee?
The following are your legal responsibility to withhold from your employees’ paychecks:
- Income taxes (Both Federal and State)
- Social Security tax
- Medicare tax
- Any health care benefits
We’ve already touched on Income taxes, Social Security, and Medicare (and how to calculate them), so let’s focus on the others here.
Briefly put, your business may want to help your employees prepare for retirement, so you may instill a 401(k) plan, in which it will then be your obligation to withhold the contributions of the employees who take part in it.
Regarding health care plans, the exact extent will be largely up to you. You may opt not to provide any employee health care plan. If you do, many employees will want to cover their premium costs through withholdings on their paychecks, so you’ll need to provide that option and stay communicative in case there are changes down the road regarding plan policies.
Garnishments are court-ordered debts that may be paid off through withholdings of paychecks rather than the employee sending payments after receiving their net pay. You’ll be legally obligated to withhold whatever percentage or amount the courts rule and also send them the withholdings instead of your employee until the debt is paid off.
Payroll withholding exemptions:
Payroll exemptions are called “allowances” and lower the amount of income taxed. The most common allowance is dependents. These take the form of children under 19 (or 24 if the child is a full-time student). Children who are permanently disabled are considered dependents regardless of their age.
Because you have to match your employees’ taxes, it’s in your best interest that they file their exemptions correctly. As part of your payroll tax management strategy, be sure to have an open door to human resources for employees to ask about exemption statuses and other concerns regarding their tax filing.
How to provide proper payroll withholding for your employees:
To summarize all that we’ve covered, here are all the steps to properly provide payroll tax withholding for your employees:
- Upon hire or any tax filing changes, collect and keep stored W-4s for all employees.
Use the W-4s to calculate individual employees:
- Total taxable earnings (also called “taxable income”)
- Federal income tax rate
Find out the current tax rates for:
- State income
- Social Security
- Using the various tax rates and your employee’s taxable earnings amount, calculate their withholdings for each separate tax.
- Finally, check and collect any additional withholdings for each employee (garnishments, 401(k), health insurance)
- Then, after paying your employees their net pay, submit the payroll taxes to the IRS according to whatever payment schedule your business follows.
- Lastly, practice proper bookkeeping and retain and secure all documentation (W-4s, tax payment receipts, paystubs, garnishment settlements, etc.) You and your employees will need the information these documents contain to file taxes and (hopefully) get a tax return.
And with that, you’ve done it! It can be a lot of work and is often the reason why businesses choose to hire a part-time bookkeeper, set up a payroll department, or outsource their payroll to a third party.
Not only will delegating your payroll needs to another party save you time and unnecessary stress, but you’ll also save on costs due to suffering fewer errors and having experts get your withholdings done correctly in a prompt and automated manner.
Or, get rid of human error altogether and invest in automated payroll solutions that modernize and streamline the payroll process and free you to focus on developing your business and resting easy that your employee’s tax needs are well taken care of.
Interested in teaming with our payroll professionals or taking advantage of our payroll solutions?
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