The U.S. withholding system, established through the Current Tax Payment Act of 1943, requires employers to withhold payroll taxes from employees’ paychecks. Amounts vary by tax, and may be based on a flat dollar amount or a percentage amount. In the latter case, depending on the tax, the withholding percentage can be a set amount or determined by a number of factors.
The Federal Insurance Contributions Act, enacted by Congress in 1937 is the law that mandates the collection of Social Security and Medicare taxes. Congress sets the percentages that the employer and the employee are required to pay in equal portions. Employers are required to withhold 6.2 percent of gross income for Social Security tax and 1.45 percent for Medicare tax from employees’ paychecks. These rates have remained constant since 1990. Social Security has a yearly wage base of $106,800; Medicare has none.
Federal Income Tax
Federal income tax calculation depends on the employee’s W-4 data and Internal Revenue Service Circular E’s withholding tax tables. The W-4 has the employee’s filing status and allowances needed to figure the tax. The employer can use the Circular E’s wage bracket method table relevant to the employee’s filing status, allowances, income and payroll tax to figure the withholding amount. This method gives a flat amount to withhold. It can use the percentage method if the employee’s earnings exceed the wage bracket income limit or if she claims more than 10 allowances on her W-4. The employer subtracts her total allowances sum (as shown on page 37 of the 2010 Circular E) from the employee’s gross income. It uses the percentage method table (as shown on pages 39-40) to figure the withholding amount.
State Income Tax
If the state requires state income tax withholding, the employer does so according to the state revenue agency’s policies. In many cases, the state has a system comparable to the federal income tax withholding, but requires the employer to use the state withholding tax tables and the employee’s state withholding allowance certificate to figure the tax. States such as Arizona and Pennsylvania require the employer to withhold based on a flat percentage of the employee’s gross taxable income.
Some cities, such as Yonkers and New York City, require city income tax withholding; the employer withholds based on the rate the government sets, which is usually included on the state revenue agency’s website. If local income tax withholding applies, such as Ohio’s school district tax, the employer withholds according to the revenue agency’s instructions. The Ohio Department of Taxation, for example, lists the withholding percentage for school district tax based on the school district county the employee lives in.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.