Have you ever wondered how your employer calculates your federal income tax withholding on your paycheck? The calculation’s not that hard to figure out if you have the right information. You can use an online withholding calculator from the IRS (NOTE: the IRS calculator does not reflect 2011 changes) or you can run the numbers yourself, which I’m going to cover here.
To perform the calculation yourself, you’ll need the following information:
• W-4, which shows your exemptions. You might have to call your Human Resources Department to get this information. It’s not a bad idea to update your W-4 annually. Remember, the more exemptions you take, the less that will be withheld from your paycheck each period. Your goal should be to get the amount withheld as close to the amount that you will owe when your taxes are due.
• Your pay rate, frequency, 401(K) contribution amount, health insurance, dental insurance, flexible spending account contributions, and any other before-tax contributions.
• IRS Publication 15 (mainly page 35 and the tables that follow).
The first step is to determine the value of your withholding allowances. You’ll first need to know the number of allowances you are claiming. Once you know that number, you’ll need to look at the chart on page 35 of Publcation 15 to find the value of each withholding allowance, based on your pay frequency.
So, if you are married, have four exemptions and you get paid semi-monthly (24 times a year), your allowances are worth $154.17 each or a total of $616.68.
Let’s say you make $6,000 per month ($3,000 per pay period). You contribute 10% to your 401(K), pay health insurance premiums of $300 per month, dental insurance premiums of $100 per month, and you contribute $100 per month to your flexible spending account. All of your pre-tax deductions amount to $1,100 per month or $550 per pay period.
Now to calculate your withholding per pay period, simply take your $3,000 in earnings and subtract your $616.68 in allowances and your $550 in pre-tax deductions, giving you a taxable amount of $1,833.32. You then look up the withholding amount, using Table 3(b) on page 36 of Publication 15, which looks like this:
You can see that we need to look at the second line down. Our taxable income is $1,833.32, so our withholding tax is $70.90 plus 15% of the amount over $1,038. The difference between $1,833.32 and $1,038 is $795.32. Our withholding tax on that $795.32 is $119.30 for a total withholding tax of $190.20.
The cool thing about being able to figure this out on your own is that you can run different scenarios to see how your 401(K) contribution amount affects your take-home pay. We’ll look at that next.