Federal income tax payroll deductions are taken only when you’re an employee. Unlike Medicare and Social Security taxes, which are withheld at flat percentages of your wages, federal income tax has multiple factors which affect withholding.
If you’re an independent contractor or self-employed, you make estimated quarterly federal income tax payments directly to the Internal Revenue Service.
Upon your hiring, your employer gives you a W-4 to complete. The number of allowances that you claim on the W-4 impacts the amount of federal income tax that comes out of your paychecks. If you claim too many allowances, you’ll likely owe the IRS when you file your return. If you claim fewer allowances than you qualify for, you’ll likely get a refund. You may use the IRS withholding calculator to help you complete the W-4 correctly.
Your federal income tax deductions are based on your taxable wages. Nontaxable benefits and pretax deductions that are excluded from federal income tax are not counted in your taxable wages. This includes IRS-qualified meal, mileage and lodging reimbursements and Section 125 health insurance and flexible spending accounts. If you have nontaxable benefits or pretax deductions, your employer subtracts the amounts from your gross pay before calculating federal income tax.
Your employer deducts federal income tax from your paychecks via the wage bracket or percentage method. In the former case, your employer applies the IRS Circular E tax table that matches your filing status, allowances, pay period and taxable wages to arrive at your withholding. In the latter case, your employer determines the value of your allowances based on the Circular E’s percentage method table that goes with your pay period. Then, it subtracts your allowance sum from your taxable wages. Next, it applies the percentage method tax table that matches your pay period, wages after allowances and filing status. In this case, federal income tax may be applied at a flat amount plus 10,15, 25, 28, 33 or 35 percent of your wages over a specific amount.
Supplemental wages, such as bonuses and severance pay, are not regular wages. If your employer pays supplemental wages with your regular wages, it calculates federal income tax as though the sum were a single payment for the regular payroll. If supplemental wages are paid separately, your employer may deduct federal income tax at a flat 25 percent. If supplemental wages exceed $1 million for the year, your employer withholds federal income tax on the excess amount at 35 percent. Some employers agree to gross-up bonuses and severance pay, so employees receive the full agreed-upon amount. In this case, the entire amount is reflected in your taxable gross wages on your W-2, but your employer absorbs the tax costs.
As a married person, you may claim “Married” or “Married, but withhold at higher Single rate” on the W-4. The former puts you in a lower tax bracket than the latter. Single filing status is the highest tax bracket. You would choose “Married, but withhold at higher Single rate” if you want more tax withheld than the married category permits. This might be necessary if you and your spouse both work and your combined income could put you both in a higher tax bracket when you file your joint tax return.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.