How to Withhold Using the Annualized Wages Method
Author: Alice Gilman
An employer must withhold federal income taxes from an employee's pay every pay period. The IRS has developed several methods an employer can use to fulfill this duty. An employer that uses automated payroll systems may find that the annualized wages method of withholding is more accurate than other withholding methods. To use the annualized wages method of withholding, an employer must use the IRS's percentage method withholding tables for an annual pay period.
All of the percentage method tables are issued before a calendar year ends and are to be used by an employer in the following year. The IRS publishes the percentage method tables in Publication 15 (Circular E), Employer's Tax Guide.
Step 1: Determine the Value of the Employee's Annual Withholding Allowance Amounts
Withholding allowances have dollar values that the IRS adjusts each year for inflation. Different withholding allowances apply to different pay periods, including an annual withholding period. An employee may claim any number of withholding allowances, or none at all, on Form W-4.
To determine the value of an employee's withholding allowances, the employer multiplies the value of one withholding allowance for an annual pay period by the number of allowances the employee has claimed on his or her Form W-4.
In 2017, Jane Johnson claims four withholding allowances on her Form W-4. Jane is unmarried. The value of one withholding allowance in 2017 is $4,050. The total value of Jane's withholding allowances is $16,200 ($4,050 × 4).
Step 2: Determine the Employee's Annual Wages
To determine the employee's annual wages, the employer must multiply the amount of wages the employee receives for a pay period by the total number of pay periods in a year. For example, an employer with biweekly pay periods multiplies an employee's wages by 26; an employer with weekly pay periods multiplies an employee's wages by 52; and an employer with semimonthly pay periods multiplies an employee's wages by 24.
In 2017, Jane is paid $3,000 on a biweekly basis. Jane's annual wages are $78,000 ($3,000 × 26).
Step 3: Determine the Employee's Taxable Wages
Once the total value of an employee's withholding allowances is determined, and the employee's pay has been annualized, the employer must subtract the value of the employee's withholding allowances from his or her annualized pay to arrive at the employee's taxable pay.
In 2017, Jane's taxable income is $61,800 ($78,000 - $16,200).
Step 4: Determine the Tax That Would Be Withheld on an Annual Basis
An employer must use the percentage method table for an annual pay period. This table has separate calculations based on an employee's marital status. Once an employer determines an employee's taxable wages and marital status, it should take the following steps:
- Find the appropriate taxable wage bracket on the left side of the table.
- Record the dollar amount of the tax to withhold.
- Subtract the amount of the employee's taxable wages that exceed the figure shown in the right hand column.
- Multiply this result by the appropriate percentage.
- Add the results from Steps 3 and 4 to arrive at the amount of income taxes to withhold from the employee's pay for an annual pay period.
For 2017, Jane's annualized withholding is $10,613.76, and is figured as follows:
- Looking at the annual percentage method withholding table for unmarried individuals, the appropriate wage bracket is over $40,250 but not over $94,200.
- The tax is $5,226.25.
- Jane's excess wages are $21,550 ($61,800 - $40,250).
- Multiply $21,550 by 25%, which equals $5,387.50.
- Add $5,387.50 and $5,226.25, which equals $10,613.75.
Step 5: Reduce the Annual Withholding Amount to the Appropriate Withholding Per Pay Period
The employer must divide the result in Step 4 by the number of pay periods by which the employee's wages were multiplied in Step 2.
For 2017, Jane's $10,613.75 in annualized withholding taxes is divided by 26, since her employer uses a biweekly pay period. This amount is $408.22. Jane's employer withholds $408.22 from her pay every biweekly pay period.