Note: Monchilla handles all federal tax calculation automatically. This article is provided for those interested in learning more about the calculation methods Monchilla uses.
The amount of federal income tax that needs to be withheld by the company from the employee paycheck and then passed on to the government can be "calculated several ways" (IRS pub 15) because it is only a rough (often very rough) estimate of how much an employee needs to pay for federal income taxes.
At the end of the year when the employee files his federal income tax return he will either receive a refund or pay the remaining amount he owes. Federal income tax withholding on paychecks can't be very accurate because it doesn't account for all of the deductions (such as interest paid on your mortgagee) that effect how much federal income tax you actually owe.
How Monchilla Calculates Federal Income Tax Withholding
Monchilla calculates the amount to withhold from an employees paycheck the most accurate way possible. Here is how we do it:
1. We take the gross wage of the employees paycheck and compare that to the number of work days in the pay period on that paycheck to determine the estimated gross income per work day.
2. We then multiply this amount by the number of work days in the year to determine the estimated annual income.
3. We then use the IRS tax tables updated each year to calculate the tax percentages that should apply. The tax table is graduated (aka messy) in that you are taxed at one rate for the first few thousand dollars a year, and then at a higher rate for next few thousand dollars, and so on until you reach the "maximum tax bracket."
While the upside of this method is that for any given paycheck the estimate will be as accurate as possible here are some downsides (most of these apply to all of the methods allowed by the IRS):
- If the gross wage of the paychecks vary the amount of federal income tax withholding will also vary. This is one of the reasons a pay period that always includes the same number of work days (like bi-weekly) is often preferable.
- If an employee has a paycheck that is larger than usual for a given pay period (bonus, overtime, etc) the estimated annual gross income will be higher and that will result in a higher percentage of federal income tax withholding.
- Determining if the calculation is correct is difficult because it is not a direct percentage like social security or medicare.
Other Methods for Calculating Federal Income Tax Withholding
Other payroll providers often select one of the other methods for calculating federal income tax withholding (possibly because it is easier for them to code). For example instead of looking at the number of work days within the pay period some payroll applications simply add up all of the paychecks issued so far this year to estimate the annual gross income. The problem with this method is that if you have paychecks that have changing pay periods your estimate will be more inaccurate. However, it is still a legitimate way to estimate the amount of federal income tax withholding and most of the time it will only vary from Monchilla's calculations by 1-3% (not bad considering how inaccurate this whole process is anyway).
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