Calculating your withholding tax can be a daunting task. Percentages, annual gross income, tax rates, and filing status can create a concoction of time consumption and frustration. Fortunately, by getting to know some basic terms and tools, your frustration will subside.
First, let’s cover some vocabulary.
- Annual Gross Income: amount of money you make from your wages, before any deductions, like taxes and benefits.
- Withholding Allowances: decided by your filing status, number of jobs and dependents you have on the Form W-4. The more allowances you claim, the less money will be withheld from your paycheck.
- Filing status: based on your family situation and marital status. You, the taxpayer, can be in one of five categories: single, married filing jointly, married filing separately, head of household, or qualifying widow(er) with dependent child.
- Tax rate: percentage rate at which your annual gross income will be multiplied by in order to quantify your taxes owed.
- Standard Deduction: an amount of money that the federal tax body lets you deduct from your annual gross income before calculating how much tax you owe.
Once you understand the vocabulary, the process will be a lot simpler. Let’s run through an example with a federal withholding table.
First, let’s set the scenario. Keep in mind that everybody’s tax scenario will be different and it’s vital you use the resources available to accurately find your taxes owed and effective tax rate.
Your effective tax rate is based on a federal withholding table that accommodates for your unique scenario. Let’s say you file under a single status on your W-4, claim no allowances and get paid bi-weekly $2,500. Annually, this would accumulate to $65,000; making up your gross income.
Because you have filed as single, you will follow the federal withholding table titled “Single.” Your standard deduction will be $6,300. You can calculate your standard deduction here. From there, what you earn over $6,300 but less than $11,625 will be taxed at 10%.
This would be $11,625 - $6,300 = $5,325 x 10% = $532.50
Next, what you earn over $11,625 but less than $40,250 is taxed at 15%.
Then, what you earn over $40,250 but less than $94,200 will be taxed at 25%.
For this example, the calculation would be $65,000 - $40,250 = $24,750 x 25% = $6,187.50
Finally, add up all the tax amounts to get your total tax liability.
For example, $532.50 + $4,293.75 + $6,187.50 = $11,013.75
With each section at a different tax rate, your effective tax rate won’t always be a flat number. In this example, $11,413.75 is 16.94% of the gross pay amount of $65,000.
Remember, this is a simplified example that does not take into account deductions that may be tax exempt and would thus change your taxable gross income.
In addition, this example only covers federal tax, not social security, medicare, state, or local taxes you may be subject to. It’s always the best idea to consult a tax advisor when navigating these calculation or managing your personal tax situation.