- A W-4 is an Internal Revenue Service form your employees fill out to let you know how much to withhold from their paycheck for taxes.
- You must also fill out Form 941 every quarter to report your payroll taxes.
- For Medicare, the tax rate is 1.45% on the first $200,000 of wages. There is also a rate of 0.9% on Medicare wages over $200,000.
Managing your company's payroll withholding is a legal obligation that requires you to assist your employees in paying a portion of their earnings as taxes to the government. As an employer, you do this by holding back a percentage of your employees' wages that you then use to pay federal, state and local taxes.
With the help of tools like W-4 forms and payroll withholding tables, you can figure out how much to remit. A lot goes into managing payroll taxes, and doing it wrong can lead to fines and fees – which small businesses especially can do without.
Keep in mind that the W-4 form received a redesign in 2019. The new draft offers a simpler application template with a more accurate system to minimize the work of payroll processors and employers.
Your company's payroll withholding tax is as integral to your business as compensating your employees, so it's important to know the ins and outs of managing the payroll withholdings for your company. Here's everything you should know as a small business owner.
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What is payroll withholding?
To handle your payroll withholdings correctly, employers and employees must work together. Payroll withholding taxes is what's deducted from employee wages. As the employer, you are mandated by law to hold back some of their earnings and give it to the government.
It is your job to calculate the pay for each employee and how much to give back in taxes based on the W-4 form they fill out at the start of their employment. A W-4 is an Internal Revenue Service (IRS) form your employees fill out to let you know how much to withhold from their paycheck for taxes.
What's new about the new W-4 form?
The IRS released a new version of the W-4 in 2019. The form is still meant to process deductions, but there are a few changes.
Employees have different filing status choices, and there is more to choose from if you've changed dependents, jobs or filing status. Your choices for filing status are single and married. The "total number of allowances" section, which included questions about your dependents and income, has been removed. The form now has an optional section ("Step 4") for adjustments, like deductions on mortgages. Regardless, employers need to be able to support both the old and the new form, said Jason Averbook, founder of Leapgen, a digital transformation company. [Check out these payroll service options to help your payroll processing run smoother.]
What taxes should you know about?
Understanding taxes is a large part of the payroll withholding process, which is why it's important to know which ones you must pay. It's also important not to avoid them, advises Al Wagner, founder and CEO of TruPayroll.
"The first thing that small businesses tend to do is not send their money into the IRS," Wagner told business.com. "Just make sure you're making your payments to the IRS. When a small business doesn't do that, they mess up cash flow, and they're held responsible. Setting up automatic payments will help you pay your taxes as quickly as possible."
Federal income tax withholding
The federal income tax amount is determined by your employee's W-4, which the employee can change at any time. This money is credited to the income taxes employees are obligated to pay throughout the year.
FICA taxes
FICA taxes are Federal Insurance Contribution Act taxes that both employers and employees must pay. Employers deduct the employee's share from their wages and then pay the other half of the amount that is due. FICA taxes are pretax deductions that are also known as Social Security and Medicare taxes.
State and local taxes
With the exception of those living in Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming, employees must pay a state income tax. Some employees must also pay local income taxes, depending on their city, school district or county.
Additional payroll deductions
Employees can sign up for optional deductions as well, like job-related expenses such as meals or uniforms. They can have money withheld for their 401(k) or retirement plans and life or health insurance premiums. Some deductions, like child support garnishments, aren't taxed.
Remember, failing to make these payments can result in fines. Averbook said outsourcing the work may be in your best interest.
"There are legal issues tied to the improper deduction of a 401(k) or health deductions," he said. "Depending on the size of the company, it could be more complex. App sourcing has become a way to protect business owners. They protect your business and make sure things are done seamlessly so you can focus on your company."
How to calculate withholding tax
If an employee checks the check box on Step 2 of their W-4, then you'll use one of two methods to determine the amount of federal withholding tax they will pay, according to IRS Publication 15-T Federal Income Tax Withholding Methods. Designed to be used in 2020, Step 2 is for employees who work multiple jobs or who are married and their spouse works.
Encourage your employees to complete Steps 3 and 4(b) for only one of those jobs. It's preferable that this job is the highest-paying one. Leave those steps blank for the other jobs.
As an employer, you can use one of two ways to calculate federal withholding tax for employees who check step 2 on their W-4: the percentage method and the wage bracket method. The employee will experience higher withholding as a result.
Percentage method
You can use the percentage method for W-4 forms from 2020, as well as those from earlier years and going forward. This method works for wages of any amount. There is no limit on the number of withholding allowances an employee can claim if a W-4 from 2019 or prior is used.
The IRS has provided tables to help you figure the correct amount of withholding. There are separate tables for those employers who use automated payroll systems and manual payroll systems.
Wage bracket method
The wage bracket method uses the employee’s adjusted wage amount, as well as their filing status, to determine the amount of federal withholding taxes they'll need to pay. There are IRS tables for both manual and automated payroll systems.
There is a separate table for those employees who have a 2019 W-4 or earlier. However, the wage bracket method works only for annual wages of around $100,000. If you have an employee whose wages top that amount, you should use the percentage method instead.
How do you manage payroll withholdings?
Once you've calculated the federal income tax and FICA tax amounts that need to be withheld from your employees' paychecks, you need to determine how much your business will have to pay for FICA taxes. For you to know how much to withhold from your employees' salaries, your staff needs to fill out their W-4s. Encourage them to use the IRS Tax Withholding Estimator to help them fill out the form correctly.
After you calculate how much money to put aside, you need to pay the IRS according to your payroll size. Payment could be made monthly or semiweekly. You must also fill out Form 941, the Employer's Quarterly Tax Return, every quarter to report your payroll taxes. It informs the IRS of the employment taxes taken from employee wages and what is owed to the IRS. Your deposit schedule is based on your total tax liability reported on Form 941.
Keep in mind that there are also unemployment taxes that aren't withheld from employees but from the employer. Unless your business is in New Jersey, Pennsylvania or Alaska, you pay your company's unemployment taxes.
What is a payroll withholding statement?
A payroll withholding statement is usually associated with a W-2 because it summarizes the employee's withholding for the year. It communicates to employees or a tax office the taxes that were withheld from the employee's wages. It comes attached to an employee's paycheck.
What is the percentage of federal taxes taken out of a paycheck?
As an employer, it's important for you to understand how much you should be taking out of your employees' checks. For Social Security tax rates in 2019, the percentage was 6.2% on the first $132,900 of paid wages. For Medicare, the tax rate was 1.45% on the first $200,000 of wages. There was an additional 0.9% rate for wages above $200,000. The same rates apply for Medicare in 2020. For Social Security tax rates in 2020, the percentage is 6.2% on the first $137,700 paid wages.
2019 and 2020 federal payroll withholding tables
Payroll withholding tables help you figure out how much of your employee's salary to keep. It’s important to stay abreast of them because they change every year. Sometimes they also include state income tax based on your company's location.
The payroll tax rate table below is from IRS Notice 1036 for wages paid in 2019. The deduction per dependent was $4,200.
| Tax | Maximum earnings | Rate |
| Social Security tax | $132,900 | 6.2% for the employee and 6.2% for employer |
| Medicare | Unlimited | 1.45% for employee and employer Additional 0.9% for the part in excess of $200,000 in a calendar year; employee only |
Table data courtesy of HalfPriceSoft.com
The payroll tax rate table below is from IRS Publication 15-T, which includes federal withholding for 2020.
| Tax | Maximum earnings | Rate |
| Social Security tax | $137,700 | 6.2% for the employee and 6.2% for employer |
| Medicare | Unlimited Over $200,000 ($250,000 for married couples filing jointly) | 1.45% for employee and employer Additional 0.9% for the part in excess of $200,000 in a calendar year; employee only |
Table data courtesy of HalfPriceSoft.com
Understanding these charts is half the battle of calculating federal tax withholding. First, you must multiply the taxable gross wages by the number of pay periods per year. A pay period is how often you pay, which can be weekly, biweekly, bimonthly, monthly or annually.
Once you have your annual wage, subtract the value of allowances for the year. To figure out your annual tax, use the table above. Then divide the amount of tax by the number of pay periods per year. This will give you the number of federal tax withholdings that should be deducted within each pay period.
What is the withholding allowance for 2019 and 2020?
The annual withholding allowance for 2019 is $4,200, according to Notice 1036. The withholding allowance amount is $80.80 weekly, $161.50 biweekly, $175 semimonthly, $1,050 quarterly and $2,100 semiannually.
Withholding allowances have been removed for 2020, per the new W-4. You cannot claim personal exemptions or dependency exemptions. In the past, withholding allowances depended on personal exemptions, but employees cannot claim them as of Jan. 1, 2020, as they are no longer on the W-4.
New hires who will receive their first check in 2020 need to use the new W-4, so remember to give the new form out to your new employees. If your employees change their withholdings, they'll need to fill out the 2020 form.