Withholding Income Taxes

By Susan Jacksack, J.D., Staff Writer, CCH Business Owner's Toolkit

Take a moment to think back to the day you received your first real paycheck. If you're like many of us, you may recall experiencing some shock upon noticing that the check amount was not quite what you'd expected. A quick glance at the accompanying pay stub showed that your employer had reduced your pay with a number of deductions, the most significant of which were probably for federal and state taxes.

Once you assume the role of an employer, you too will be required to withhold taxes from your employees' pay and to deposit the withheld amounts with the appropriate tax agencies. Furthermore, as an employer, you'll be personally liable for paying certain taxes on the amounts you pay your workers.

Together, those taxes that you're required to withhold and those that you're directly required to pay comprise your payroll taxes. Specifically, by hiring employees, you take on the following payroll tax obligations:

• to withhold federal, state, and local income taxes
• to withhold an employee's share of Social Security and Medicare taxes (which together are called FICA taxes), and to pay an equal amount as the employer's share
• to pay federal and state unemployment taxes
• to pay and/or withhold state disability insurance taxes, if required in your state
• to pay all these taxes on time and to file any required returns or reports.

For purposes of this column, let's focus on the first one -- withholding federal, state, and local income taxes.

Federal taxes. Whenever you pay wages or other compensation to an employee, you can assume that the IRS will expect you to collect a portion of the employee's federal income tax on the payment by withholding the taxes from the employee's paycheck. Depending on where you do business, you may also have an obligation to withhold state and local income taxes.

Once you've determined the amount of each employee's paycheck that is subject to withholding, calculating the dollar amount to withhold is fairly straightforward.

Although the law provides specific rules for calculating that amount, the IRS and your state tax agencies have reduced the rules to simple tax tables that you can use in most cases. The tables show you how much you have to withhold on a payment, given the employee's marital status, your payroll period, and the number of withholding exemptions the employee claims on the W-4 form.

You can get a copy of the federal tax tables by calling 1-800-TAX-FORM and asking for Circular E and the supplement to Circular E, both of which are free publications that are updated annually.

State taxes. If you do business in a state that imposes a personal income tax, you can add the withholding of the state tax to your list of payroll tax responsibilities.

All but nine states impose a personal income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Every other state has a personal income tax, and requires employers to withhold the tax from employees' wages.

Most states allow employers to use methods that are similar to those used for federal tax purposes in determining their state income tax withholding amounts. With the exception of Arizona and North Dakota, where the state withholding amount is a fixed percentage of the federal withholding amount, and Pennsylvania, where the state withholding amount is a fixed percentage of an employee's gross wages, all of the states provide wage-bracket tables as one of the alternatives for computing state withholding amounts.

If you only do business in one state and all of your employees are residents of that state, your state withholding obligations will be quite similar to your federal withholding obligations. However, complexities can arise once your operations expand beyond the borders of a single state.

More difficult situations arise when you send your employees to other states to perform services or employ residents of other states at a single in-state site. In these situations, we recommend that you seek the advice of your accountant or other tax professional.

Local taxes. In a few states (California, Colorado, Delaware, Illinois, Indiana, Kentucky, Michigan, Missouri, New Jersey, New York, Ohio, Oregon, and Pennsylvania), there are cities, counties, and other local governmental units that impose their own income tax. And if you happen to do business in one of these localities, you may very well have an additional income tax withholding obligation. Apart from local income taxes, you may also find yourself paying local taxes measured by your total payroll (payroll expense taxes) or withholding local occupational fees from your employees' wages.

To keep up-to-date regarding all the tax law changes affecting your taxes and your business, be sure to pick up a copy of CCH Business Owner's Toolkit Tax Guide 2001. This easy-to-use tax reference--and accompanying FREE offer for online tax return preparation and filing--is available at major booksellers nationwide, by calling 1-800-248-3248, or by visiting our online bookstore.