The Mathematics of Money

390 Chapter 9 Taxes

Income Tax Withholding

While income taxes are calculated and owed on the basis of the taxpayer’s annual income,

the government is not content to sit around and wait until the end of the year to collect the

tax owed. The income tax you owe for your income must be paid when you earn it. To

make sure that this happens, employers are responsible for withholding money for taxes

from their employees’ paychecks and forwarding this money to the Internal Revenue Ser-

vice (for federal taxes) and state (and/or city or county) tax agencies.

An employer is responsible for withholding taxes on the basis of withholding rates published

by the IRS (and state/local tax agencies for state/local taxes). The employer then forwards the

taxes withheld to the appropriate government tax collection agencies. The 2006 withholding

rates for an employer using a biweekly pay schedule are given as an example below:^5

SINGLE PERSON (INCLUDING HEAD OF HOUSEHOLD)

IF THE AMOUNT OF WAGES (AFTER

SUBTRACTING WITHHOLDING

ALLOWANCES) IS:

THE AMOUNT OF INCOME TAX TO

WITHHOLD IS:

Over But not Over of Excess Over

$0 $102 $0

$102 $385 10% $102

$385 $1,240 $28.30 plus 15% $385

$1,240 $2,817 $156.55 plus 25% $1,240

$2,817 $6,025 $550.80 plus 28% $2,817

$6,025 $13,015 $1,449.04 plus 33% $6,025

$13,015 $3,755.74 plus 35% $13,015

MARRIED PERSON

IF THE AMOUNT OF WAGES (AFTER

SUBTRACTING WITHHOLDING

ALLOWANCES) IS:

THE AMOUNT OF INCOME TAX TO

WITHHOLD IS:

Over But not Over of Excess Over

$0 $308 $0

$308 $881 10% $308

$881 $2,617 $57.30 plus 15% $881

$2,617 $4,881 $317.70 plus 25% $2,617

$4,881 $7,517 $883.70 plus 28% $4,881

$7,517 $13,213 $1,621.78 plus 33% $7,517

$13,213 $3,501.46 plus 35% $13,213

Note that different rates apply depending on filing status, and these rates apply to the

amount of wages after subtracting withholding allowances (withholding allowances are

roughly equivalent to the deductions for dependents). This reflects the effects of different

filing statuses and numbers of dependents. Each employee is required to file a W-4 form

with his employer to indicate his dependent exemptions and filing status; the employer

then bases his tax withholding on the information supplied on this form.

The amount of each withholding allowance is the annual allowance divided by the

number of pay periods in the year. For example, the annual allowance for 2006 is $3,300,

so for someone paid biweekly the withholding allowance would be $3,300/26  $126.92

for each exemption claimed. Also, the amount an employee pays toward the cost of benefits

like health insurance or contributes to a retirement account like a 401(k) is normally not

taxable and hence is not included when calculating the amount of withholding.

(^5) Source: U.S. Internal Revenue Service, http://www.irs.gov. Reformatted.