Practicing Calculations Ensures Withholding System Accuracy

Understanding federal income tax withholding calculations is key to ensure that payroll systems properly calculate the amount of tax to withhold, a payroll professional said July 14.

The withholding accuracy of payroll systems should be tested not only upon the implementation of a new system, but every time the federal withholding tables change, said Sally Hilton, CPP, director of Payroll Training for the American Payroll Association.

Employers are responsible for accurate withholding and may incur penalties for underwithholding, Hilton said at the American Payroll Association’s Virtual Congress.

Employers should familiarize themselves with the components of Form W-4, Employee’s Withholding Certificate, and the withholding calculations in Publication 15-T, Federal Income Tax Withholding, Hilton said. The form and the withholding calculations were significantly revised in 2020.

Practicing withholding calculations manually using the worksheets introduced in Publication 15-T may help employers identify potential withholding errors in electronic systems, Hilton said.

On Forms W-4 issued in 2020 or later, employers must take into account an employee’s tax filing status, claimed tax credits, non-job income and other withholding circumstances indicated on the form in order to calculate withholding, Hilton said. Pay frequency, pretax deductions, and whether the wages are regular or supplemental also must be taken into account.

Publication 15-T includes several worksheets for calculating income tax withholding.

Payroll software often relies on Worksheet 1, Percentage Method Tables for Automated Payroll Systems, to calculate withholding, Hilton said. Worksheet 1 may be used with any Form W-4, regardless of the year the form was issued.

Worksheets 4 and 5 also rely on the percentage method of withholding and are year-specific, Hilton said.

Worksheets 2 and 3, which rely on the wage bracket withholding method, likely are to be used when an electronic system is not able to be used, Hilton said. The tables may not be used for wages exceeding the maximum amounts included in the tables.

Publication 15-T also contains a computational bridge that allows employers to treat a pre-2020 Form W-4 as if it were a Form W-4 issued in 2020 or later, Hilton said. The bridge likely is useful to employers using an in-house payroll system and that would otherwise need to maintain two separate calculation systems for the different versions of Form W-4, she said.

Payroll systems also should be able to properly calculate withholding on supplemental pay, Hilton said. The optional flat withholding rate of 22% may be used when tax has been withheld from regular wages in the current or preceding year; the mandatory flat rate of 37% is required when supplemental wages paid year-to-date equal or exceed $1 million.

The aggregate withholding method may be used when year-to-date supplemental wages are less than $1 million and is required to be used when an employee has not had tax withheld in the current or preceding year, Hilton said. The aggregate method may be preferable to the flat rate methods when withholding from a large supplemental wage payment, she said.