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4 Min. Read

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

Small businesses need to calculate withholding tax to know how much money they should take from employee paychecks to send to the Internal Revenue Service to cover tax payments. Employers calculate withholding tax by referring to an employee’s Form W-4 and the IRS’s income tax withholding table to determine how much federal income tax they should withhold from the employee’s salary or wages. There are two main methods small businesses can use to calculate withholding tax: the wage bracket method and the percentage method. To calculate withholding tax, you’ll need the following information:

Small business owners should learn how to calculate withholding taxes to make sure employees are being taxed at the correct rate.

These topics take you through how to calculate withholding tax:

How to Calculate Withholding Tax

What Are Withholding Allowances?

What Is the Income Tax Rate for 2018?

NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. If you need income tax advice please contact an accountant in your area.

How to Calculate Withholding Tax

To calculate withholding tax, the employer first needs to gather relevant information from the W-4 form, review any withholding allowances and then use the IRS withholding tables to calculate withholding tax. Here are the steps to calculate withholding tax:

1. Gather Relevant Documents

First, gather all the documentation you need to reference to calculate withholding tax. The withholding tax amount depends on a number of factors, so you’ll need the employee’s W-4 to help with your calculations, as well as the withholding tax tables and the IRS worksheet.

2. Review the Employee’s W-4 Forms

Next, refer to the employee’s Form W-4 to find the following information relevant to the withholding tax calculations, including their filing status, number of dependents, additional income information, and any additional amounts that the employee requests to be withheld. 

3. Review Payroll Details

You’ll need to gather information from payroll to calculate employee withholding tax. Here’s the information you’ll need for your calculations:

  • Payroll period details, including the frequency of your pay periods (weekly, biweekly or monthly) and the amount of time for that particular period
  • The gross pay amount for the pay period, i.e. the total amount paid for the pay period, either in salary or wages

4. Choose Your Calculation Method

Once you’ve gathered all the W-4 and payroll information you need to calculate withholding tax, you need to choose a calculation method. There are two methods you can choose from:

  • The Wage Bracket Method: The wage bracket method of calculating withholding tax is the simpler of the two methods. You’ll use the IRS income tax withholding tables to find each employee’s wage range. The instructions and tables can be found in IRS Publication 15-T
  • 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 employees wage amount, accounting for tax credits, and calculating the final amount to withhold.

What Are Withholding Allowances?

Withholding allowances were exemptions that employees used to use to claim from federal income tax, using Form W-4. Withholding allowances were used to determine an employee’s withholding tax amount on their paychecks. The more allowances an employee choose to claim, the less federal tax their employer deducted from their pay. 

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

What Is the Income Tax Rate for 2020?

The federal income tax has seven tax rates for 2020: 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. You can find your 2019 and 2020  federal income tax rate based on your filing status by using the IRS income tax rates and brackets