How does federal tax withholding work?
The IRS describes federal income taxes as a pay-as-you-go system: taxes are due each pay period when employees receive their wages. Business owners must take the appropriate amount of income tax, along with other payroll taxes, directly from wages, vacation pay and commissions. You must accurately track the federal taxes you’ve deducted and deposit the funds electronically with the U.S. Treasury in the employee’s name.
The amount collected is reconciled by the IRS each year when annual income taxes are filed, and the employee either pays a balance owing or receives a refund. Each employee should have at least 90% of their estimated income taxes withheld to avoid owing a large amount at the end of the year.
Determining how much tax to withhold
When calculating the amount of tax to withhold for an employee, you need to have the following information on hand.
Form W-4
The amount of tax you withhold for an employee is based on what they report on Form W-4, known as the Employee’s Withholding Allowance Certificate. This form lists personal information that affects an employee’s federal tax payable, such as filing status, marital status, dependents and other income. Form W-4 was redesigned in 2020 to reflect a new withholding system that’s no longer based on federal withholding allowances.
Ask your newly hired employees to complete this form and keep it on file so you can calculate how much federal tax to deduct each pay period. Employees are responsible for providing you with an updated Form W-4 if their personal circumstances change or they want to adjust the amount being withheld.
Federal withholding tax tables
Each year, the IRS publishes tax withholding tables that show how much tax should be deducted from employee earnings. You can find 2020 tax tables, and instructions on how to use them, in Publication 15-T.
The publication contains numerous tables based on whether you have an automated or manual payroll system, the method used to calculate withholding, and whether you’re using an older version of Form W-4.
Employee pay information
The amount of tax you withhold is calculated using an employee’s earnings, so you must know the total wages earned by the employee during the specific pay period, and the number of pay periods for the year.
How to use the 2020 tax tables
Once you have gathered the above information, you can begin.
Locate the appropriate federal withholding tax table
Publication 15-T contains different federal withholding tables organized as follows:
- Percentage Method Tables for Automated Payroll Systems
- Wage Bracket Method Tables for Manual Payroll Systems With Forms W-4 From 2020 or Later
- Wage Bracket Method Tables for Manual Payroll Systems With Forms W-4 From 2019 or Earlier
- Percentage Method Tables for Manual Payroll Systems With Forms W-4 From 2020 or Later
- Percentage Method Tables for Manual Payroll Systems With Forms W-4 From 2019 or Earlier
Find the correct table for your calculations.
Complete the withholding worksheet
Complete the worksheet for the appropriate table, using information from Form W-4 and the employee’s pay details. The worksheet provides line-by-line instructions to help you figure out an adjusted wage amount. You must then locate this amount on the 2020 tax tables based on the employee’s earnings and filing status to see how much to withhold
For detailed information on withholding taxes, you should also consult Publication 15, Employer’s Tax Guide.
Using the IRS Income Tax Withholding Assistant
The IRS introduced a tool at the end of 2019 to make it easier for business owners to calculate withholding amounts. You may find it more convenient to use the Income Tax Withholding Assistant than the federal withholding tables in Publication 15-T.
The tool is designed as a downloadable Microsoft Excel spreadsheet. You can save a separate copy of the spreadsheet for each employee.
To set up the spreadsheet for an individual employee:
- Open the spreadsheet
- Enter the requested information, including details from the employee’s Form W-4
- Save the spreadsheet with a file name that includes the employee’s name
Each pay period, you can open the file and enter the wages earned for the pay period. The spreadsheet automatically calculates the amount you should withhold.
