How to Calculate Wage Deductions
Wage deductions can be involuntary or voluntary. Involuntary deductions are those that a statutory institution requires the employer to withhold from employee's wages. Voluntary deductions are those that the employee consents to have deducted from her paycheck. The calculation for wage deductions varies by deduction type.
Involuntary deductions include federal income tax, state income tax, Medicare tax, Social Security tax, wage garnishments, child support orders and, occasionally, local or city income tax. Voluntary deductions include employer-sponsored benefits, such as medical, dental and retirement plans; flexible spending accounts, such as child care assistance; parking fees; union dues; charitable contributions; and disability insurance.
Federal payroll taxes provide funding for national programs, such as defence, foreign affairs, and law enforcement; hospital benefits for employees, retirees and their spouses upon reaching age 65; and retirement benefits for the disabled and retirees and their dependents. State income taxes fund state public services, such as education, corrections and rehabilitation, and transportation and housing. The employer offers voluntary deductions as a benefit to employees. Voluntary deductions can be pre-tax (before tax) or post-tax (after tax).
The employer uses the employee's W-4 form and IRS Circular E to compute federal income tax withholding. The amount is based on the employee's filing status and allowances -- as shown on the W-4 -- and Circular E's federal withholding tax tables. The IRS allows employees to claim allowances for each dependent, which reduces taxable wages. Consequently, the more allowances the employee claims, the less her federal income tax withholding.
The employer withholds state income tax according to the state revenue agency's guidelines. The state income tax withholding system is usually similar to the federal system's except that the employer uses the respective state withholding tax table and the employee's state withholding allowance certificate to compute state withholding. In rare cases, such as in New York City or Ohio, city or local taxes may apply. In this case, the employer makes the deduction according to the respective agency's guidelines.
Social Security and Medicare taxes are commonly called FICA taxes. The employer deducts 6.2 per cent of gross income, up to the annual wage maximum of £69,420 for Social Security tax. It deducts 1.45 per cent of all gross income for Medicare tax. The employer pays an equal portion of Social Security and Medicare taxes.
The wage garnishment paperwork shows the amount to garnish from the employee's wages. Federal law says the employer cannot deduct more than 25 per cent of disposable earnings for a wage garnishment.
Pre-tax voluntary deductions, such as contributions to traditional 401k plans, are deducted from wages before taxes are withheld; this lowers taxable wages. Post-tax deductions, such as Roth 401k and donations, are deducted after taxes are withheld, and therefore do not reduce taxable wages.
The deduction amount varies by deduction type and the employee's pay frequency. For instance, the employee may opt to contribute 5 per cent of her gross earnings toward her 401k every weekly payday. If she were paid biweekly, a larger amount would be deducted since her pay and the contribution would be based on two weeks instead of one.