Payroll Processing-Calculate Net Pay

Payroll processing requires calculating gross pay and the necessary withholding taxes which include: income tax, social security tax and Medicare tax. There are several ways to calculate and figure income tax withholding.

Employers can calculate federal income tax withholding by using either the "Wage Bracket Method," or the "Percentage Method."

To use the wage bracket method, find the proper withholding table from IRS Publication 15 for your payroll period (daily, weekly, semi-weekly, semi-monthly, monthly) and the employee's marital status (single or married) as shown on his or her Form W-4. Then, scroll down the table's income column until you find the row matching your employees gross pay for this pay period.  Then follow the withholding allowance columns from 0 to 10 until you find the number of withholding allowances your employee claimed on his or her Form W-4. At the intersection of the wages row and withholding allowance column, you will find the amount of federal income tax to withhold.

If you cannot use the wage bracket tables because wages exceed the amount shown in the last bracket of the table, use the percentage method of withholding described below. Be sure to reduce wages by the amount of total withholding allowances in IRS Tax Table 1 before using the percentage method tables.

If you do not want to use the wage bracket tables to figure how much income tax to withhold, you can use a percentage computation based on Table 1 and the appropriate rate table. This method works for any number of withholding allowances that the employee claims and any amount of wages.

Use these steps to figure the income tax to withhold under the Percentage Method:

    
1. Multiply one withholding allowance for your payroll period (see Table below) by the number of allowances that the employee claims.
    
2. Subtract that amount from the employee's wages.
    
3. Determine the amount to withhold from the appropriate IRS Tax Table.

Example: An unmarried employee is paid $600 weekly. This employee has in effect a Form W-4 claiming two withholding allowances. Using the Percentage Method, figure the income tax to withhold as follows:

Social Security withholding is calculated by multiplying gross wages for the pay period by the social security tax rate of 6.2%.  Withhold social security taxes until the employees' gross wages reach $90,000 in 2005. The wage base for 2004 was $87,900.  The withholding threshold changes every year in tandem with an increase in social security benefits.

Medicare taxes are withheld from the employees gross pay at the rate of 1.45%. There is no limitation on wages for Medicare taxes and there are no withholding allowances for social security and Medicare taxes.

Generally, employee wages are subject to social security and Medicare taxes regardless of the employee's age or whether he is receiving social security benefits.

Successor Employer If you received all or most of the property used in the trade or business of another employer, or a unit of that employer's trade or business, you may include the wages that the other employer paid to your acquired employees before the transfer of property when you figure the annual wage base limit for social security.

See Regulations section 31.3121(a)(1)-1(b) and Revenue Procedure 2004-53 for more information.

Part-Time Workers For federal income tax withholding and social security, Medicare and federal unemployment (FUTA) tax purposes, there are no differences among full-time employees, part-time employees and employees hired for short periods. It does not matter whether the employee has another job or has the maximum amount of social security tax withheld by another employer.