Though tax and paycheck deductions are a routine part of any payroll process, employers and employees alike tend to question what, exactly, goes into the deduction formula. We all start out with a gross pay amount, but just how do payroll managers arrive at the net pay for each paycheck?
As an employer, there should be no mystery when it comes to money and where it goes, so here is a basic breakdown of what you have to withhold from a paycheck.
Per the IRS’s protocol, every paycheck is subject to several state- and federal-based deductions, including the following:
- Federal income tax
- FICA (Social Security and Medicare) tax
- FUTA (Federal Unemployment Insurance Tax)
- State income tax
- Local income tax
Bookmark our 2016 Tax and Wage Alert for the current rates
These taxes are withheld on a per-paycheck basis because federal law prohibits employers from charging a year’s worth of taxes to a single pay period, which would likely result in missing one or more paychecks toward the end of the cycle. The only exception to this rule lies with freelance contractors who generally must fill out a 1099 form at the end of every year—for your own records, keep this in mind if you hire contractors.
As an employer, you are partially responsible for FICA taxes insofar as you must match your employees’ tax amount per paycheck. The Social Security tax rate for 2016 is 6.2 percent, while the Medicare tax rate is 1.45 percent, and your company must match every percentage point of these deductions. Federal income tax and FICA apply across the board, and though federal income tax will differ based on a number of factors (e.g., salary, employee status), FICA taxes are fairly consistent.
State income taxes and local income taxes are a bit trickier, as they pertain to specific states, districts, counties, or otherwise municipal locations potentially outside of your realm of experience. To accurately deduct these values, you’ll need to consult pertinent state legislature, as the implications of different municipalities and states differs wildly. For instance, there are 9 states that don’t collect an income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. States also may require their own Unemployment Tax percentages.
For example, most of Oregon does not have local income tax, but Multnomah County mandates a 1.45 percent business income tax. In a case such as this, you would have to pay that 1.45 percent if your business resided in Multnomah County and you lived within the taxable municipality. You can read more on local tax rates here.
Under normal circumstances, commuting employees working in an area with an applicable local income tax must pay that tax as long as their home address is within the boundaries thereof; Pennsylvania is the only state in which this rule holds untrue, wherein employees must pay local income tax whether they live in the same municipality as the business or not, but does offer a reciprocity for state income taxes with its neighboring states.
Other Paycheck Deductions
While we covered the standard paycheck deductions, there are certain deductions that will vary from employee to employee. This may include wage garnishments, retirement plan contributions, health benefits coverage and premiums, flexible spending and/or health savings accounts, and payroll-deducted charitable contributions. Any other applicable deductions, such as repaying debt to an employer, must be voluntarily authorized by the employee in writing.
A paycheck may also reflect a change in pay in event the employer adjusts an employee’s salary based on un-paid leave or time off taken in full-day increments, or in the first or final week of employment so that the employee’s pay reflects his or her actual hours worked within the pay period.
Exceptions to Withholding
Of course, each employee will have minute differentiations in their taxable income—a phenomenon that their W-4 should corroborate. Most employees will have at least one extenuating exemption such as marital status, their number of dependents, payroll frequency, and wage size. To ensure maximum accuracy during payroll calculation, have your employees update their W-4s as soon as they have a change in exemptions in addition to the yearly W-4 renewal.
Another example of an exception is the Social Security ceiling—the figure at which Social Security is no longer deducted. For 2016, the ceiling is 118,500 dollars; after an employee has earned this figure, they don’t have to pay Social Security. Though the demographic to whom this ceiling applies is decidedly small, it’s something of which you should be aware.
Paycheck Deductions: What You Can’t Withhold
Of course, there are a few things you cannot legally deduct from an employee’s paycheck. The difference between reported register contents and actual contents, costs of uniforms, materials, and job-related tools, and theft of the employer’s property are a couple examples that are rarely applicable to an employee’s paycheck. The FLSA, along with state laws, mandates that employees are not required to pay for such items, especially if it puts their wages and overtime below what is required by law.
Additionally, there are a few states that allow almost zero employer intervention on paychecks—for example, California doesn’t allow employers to charge their employees for uniforms, outstanding debts, or damage to the company without extensive legal intervention first.
Paycheck deductions are a huge part of accurate payroll, and getting them right means the difference between a smooth operating year and huge fines from the IRS. To ensure your accuracy in this process, call Abacus Payroll at 856-667-6225, fill out our fast payroll quote form, or send us an email.
About the Author: Abacus Payroll
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