How to Calculate Withholding Tax (4 Easy Steps)

Small businesses need to calculate withholding tax to know the amount of federal tax that should be withheld from employee paychecks and sent to the Internal Revenue Service to cover their annual tax liability.

Employers calculate tax withholding by referring to an employee’s Form W-4 and the IRS’s federal income tax withholding table to determine how much federal income taxes they should withhold from the employee’s salary or wages. 

There are two main methods small businesses can use to calculate federal withholding tax: the wage bracket method and the percentage method. 

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

In this article, we’ll cover:

• How to Calculate Withholding Tax
• What Are Withholding Allowances?
• Income Tax Return Rates for 2022 and 2023

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 federal income tax withholding. 

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. To calculate withholding tax, you’ll need the following information:

• Your employees’ W-4 forms
• Each employee’s gross pay for the pay period
• The IRS income tax withholding tables (IRS Publication 15-T) and tax calculator for the current year

2. Review the Employee’s W-4 Forms

Next, make sure you have the correct form. You’ll need to refer to the employee’s Form W-4 to find the following information relevant to the federal income tax withholding calculations, including their filing status, number of dependents, additional income information, tax deductions, and any additional amounts that the employee requests to be withheld, which contribute to the calculation of FITW tax. 

Any major life change, such as getting a new job, getting married or divorced, or having children, can have a big impact on the federal taxes an employee owes. So it’s a good idea for employees to review their income tax withholding and update their W-4 when their circumstances change.

3. Review Payroll Details

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

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

4. Choose Your Calculation Method

Once you’ve gathered all the W-4 and payroll information you need to calculate tax withholding, you need to choose a calculation method. There are 2 methods you can choose from:

The Wage Bracket Method

The wage bracket method of calculating tax withholding 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.

Keep in mind that these instructions only cover withholding federal income tax. Depending on where employees live or work, you may also need to withhold state income taxes and local income taxes. Employers also need to withhold taxes for the Federal Insurance Contributions Act (FICA), which covers Social  Security and Medicare taxes.

What Are Withholding Allowances?

Withholding allowances are exemptions that reduce the amount of income tax you deduct from your employee’s paycheck. Employees claim allowances on Form W-4. The more allowances an employee claims, the less federal tax their employer deducts from their pay. 

Employees can use the IRS’s Tax Withholding Estimator tool to calculate how these allowances might affect their take-home pay.

Income Tax Return Rates for 2022 and 2023

Tax liability is incurred when you earn taxable income—that’s your gross income minus any allowable tax deductions. So when looking at your income tax returns, you need to check what income tax rate applies to you. Tax returns can be broken down into the following federal tax brackets:

• 10%
• 12%
• 22%
• 24%
• 32%
• 35%
• 37%

These are the rates for any taxes that are due in April 2023 or April 2024.

For someone using the single, married filing jointly, married filing separately, or head of household filing status, the income tax rate for 2022 would be as follows:

For 2023, the federal income tax brackets for each filing status look like this:

Need more information? Learn more about how to calculate payroll taxes, including federal, state, and local taxes. Or, read some tips on how to do your own payroll taxes for your small business.

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