The Employer’s Guide to Federal Income Tax Withholding

When you run a business, the word taxes might fill you with dread—especially if you have employees. You pay some employment taxes (e.g., unemployment), while others are taxes you deduct from your employees’ wages and pay on their behalf. One of the taxes you must withhold is federal income tax. So, what is it, and how do you calculate federal income tax withholding (FITW)? 

What is federal income tax withholding?

There are a few types of federal taxes you need to withhold from each of your employees’ paychecks, including:

Both Social Security and Medicare taxes are fixed-rate taxes you withhold from your employees’ wages and pay on behalf of your employees. Social Security is 6.2% for both employee and employer (for a total of 12.4%). Medicare is 1.45% for both employee and employer, totaling a tax of 2.9%. These two taxes (aka FICA taxes) fund specific federal programs. 

Federal income tax withholding varies between employees. The IRS bases FITW on the total amount of taxable wages. Unlike Social Security and Medicare taxes, federal income taxes do not go to one specific program. The government uses federal income taxes from employees to fund a number of programs (e.g., defense and veteran’s benefits). 

Because federal income tax withholding varies between employees, how do you calculate the taxes?

How to calculate federal income tax withholding

Every employee has a different FITW. Why, you may be asking? The IRS determines federal income tax based on factors that vary between employees, including:

  • Number of dependents
  • Filing status (e.g., head of household)
  • Pay frequency

While you can calculate federal tax withholding by hand, you may choose to simplify the process by using payroll software. Payroll software automatically calculates federal income tax withholding for you when you process payroll, saving you time. 

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If you decide to calculate FITW by hand, use IRS Publication 15 and IRS Publication 15-T to calculate the withholdings. Publication 15 gives detailed information about FITW and how to tax different types of income for your employees. The IRS tax tables and FITW worksheet are in Publication 15-T. 

The IRS uses two different methods to calculate federal income tax withholding: the wage bracket method and the percentage method. Both ways give you similar calculations. Reference Publication 15-T for charts and other information to help you choose which method works best for you. 

Once you decide which federal withholding tax table you want to use, gather information from your employee. You need the pay frequency for your employee, their total earnings for the pay period, and the information on their Form W-4. Use all of the data to calculate their federal tax withholdings. 

Form W-4

Again, you need Form W-4 information to calculate income tax withholdings for your employees. But, what is Form W-4? 

Form W-4, sometimes called a W-4 Form, is the document employees use to notify their employer of tax withholdings. You should have your employees complete this form when they begin working for you. Your employees list their filing status (e.g., single), number of dependents, and any additional withholdings on the form. 

Claiming dependents decreases withholdings, as does using the deductions worksheet on the Form W-4. Employees can increase their withholdings by listing an additional amount to withhold from each check for federal income tax. 

For example, an employee who is single with zero dependents has the maximum amount of FITW taken from each paycheck. An employee who is single with one dependent has less federal income tax withheld from each paycheck. 

An employee who files under a married or head of household status also has less income tax withheld than an employee who files as single. 

Exemption from withholding

You may hire an employee who is exempt from federal withholding. In the case of an exemption, do not withhold any federal income tax from the employee’s paychecks. 

Employees must indicate if they are exempt from FITW on Form W-4 on Step 4(c) by writing “EXEMPT.” 

Depositing federal income tax

Once you calculate your employee’s withholding, the IRS requires that you deposit the taxes on a regular schedule. Do not keep the taxes or use them for other purposes. Keeping or using the money is illegal, and you could be subject to civil and criminal sanctions.

The IRS determines your income tax deposit frequency and will notify you of any changes. The two deposit schedules are monthly or semi-weekly. 

You must pay monthly deposits by the 15th of the month following the end of the calendar month. For example, January deposits are due on February 15th. If the 15th of the month falls on a weekend or holiday, deposit the taxes the next business day. 

Semi-weekly deposits depend on your pay date. If your payment date falls on a Wednesday, Thursday, or Friday, deposit the taxes by the following Wednesday. Pay dates that occur on Saturday, Sunday, Monday, or Tuesday have a deposit date of the following Friday. 

The IRS uses your Form 941 to determine your deposit schedule based on a specified lookback period. Further instructions for deposit schedules are available in Publication 15. 

Deposit your FICA taxes at the same time you deposit the FITW. 

Use the Electronic Federal Tax Payment System (EFTPS) to deposit the taxes electronically. If you do not make your deposits on time, you may have to pay a penalty. 

Reporting federal income tax

You need to report how much federal income tax you deposit. To do this, use either Form 941 or Form 944.

File Form 941 by the last day of the month following the end of the quarter. The filing schedule deadlines for Form 941 are:

  • April 30 for the first quarter
  • July 31 for the second quarter
  • October 31 for the third quarter
  • January 31 for the fourth quarter

Form 944 is an annual form due on January 31 of the following year. Only use Form 944 if the IRS notifies you in writing that you must use this form and not Form 941.

Federal income tax withholding errors

While mistakes can happen, you must correct any mistakes by filing a corrected form. Use Form 941-X to correct any errors on your quarterly forms and check which quarter you are correcting. Form 944 has a correction form as well—Form 944-X

If you withhold and deposit too much tax, submit the correction form to the IRS for a refund. Should you discover an error where you did not calculate or deposit enough tax, use Form 941-X (or Form 944-X) to fix the mistake and submit a payment to the IRS for the owed amount. 

This article has been updated from its original publication date of May 10, 2017.

This is not intended as legal advice; for more information, please click here.

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