I can take the tax brackets and figure out a person’s marginal tax rate based on their paycheck. But TBH I have no clue if that is how it is actually done. Plus figuring how the W4 exemption impact the withholding - well I have no clue how that works although I would guess it is like above i.e. calculating the gross annual pay from the paycheck and then using the W4 to account for personal deduction, filing status (single vs married), children, child care credit, etc, to extrapolate the adjusted gross income.
So can someone give me the background calculations of how the gross pay and info on the w4 work out?
Do Americans not have a tax code? In the UK we are all given a code from which a payroll clerk can calculate the deductions. (L1100 would mean that the first £11,000 in the year is tax free.)The codes are issued annually and relate to the previous year, so may not reflect actual circumstances. This is normally resolve in the following year as an extra charge or a rebate.
This applies to employed as well as self-employed, although and employed person (whose circumstances tend to remain fairly static) does not have to do an annual return. Even an employed person can elect to make a return if they think they are being overcharged.
It’s not just using the tax brackets because you have to take into account pre-tax contributions (like 401(k) and health premiums) plus the number of exemptions on the W-4. Here’s a pretty good rundown:
I’m not sure what you’re asking here. Do you want to know the reasoning behind why the IRS does things the way they do? Or do you want to know what procedures employers use to do the calculations? Those are very different things.
If you’re asking what the procedure is, I have two answers.
The smart-ass answer is that the companies hire an accountant to do it for them, or they buy some software that does the calculations and spits out an answer. But that’s like answering the question “How do you multiply 102 by 6?” with the answer “Use a calculator or ask someone who’s good at math”. Not very helpful.
So, here’s my trying-to-be-helpful answer. First, you get the number of allowances from the employee’s W4, and look at their filing status (single, married, etc.). Then you find the appropriate tables in IRS Publication 15 (which is updated every year), depending on whether the paychecks are monthly, weekly, whatever. My company does monthly paychecks, so the process goes like this: First, multiply the number of allowances by $333.30 and subtract that from their gross pay. If the result is less than that $192, then the tax is $0. If it’s between $192 and $960, then you withhold 10% of the amount which is over $192. If it’s between $960 and $3,313, then you withhold $76.80 plus the 15% of the amount which is over $960. So, for example, if a single employee has two allowances and makes $1,645 in a month, you take 2x333.30=666.60 and subtract is from 1,645 which leaves 978.40, which is more than 960, so you take 978.40-960=18.40, calculate 15% of that, which is 2.76, and add 76.80+2.76= $79.56 and that’s the amount you withhold this month.
Now, if you want know WHY the IRS came up with those particular tables in Publication 15, then that’s another discussion.
Americans do not have a tax code. The tax system is way too complex to work like the UK. There are more tax brackets (seven) and many more things that are tax deductible. Plus taxes are rarely deducted at source on things like interest and dividends - which tax level would you deduct at? And you have exemptions and deductions, which can vary significantly from year to year. And if you earn too much you start to lose them again.
Almost everyone has to submit a tax return and it is so complex that the majority need professional help to file their returns, although online programs are helping reduce that.
My 2014 Federal tax return was 28 pages long. Then there was my state tax return - another 18 pages. Strictly speaking, I should file for another state also, but as it would result in a small refund, I decided it was not worth my time to bother.
So the way withholding from pay works is that the employee fills in a form (W-4) with main details of things like how many dependents you have and then the company/payroll processor (mis)calculates how much tax you should pay and withholds accordingly. You have to calculate yourself if you need more tax withheld to allow for your various other tax-related circumstances. This system generally results in too much tax being withheld, and people get the excess back as a refund when they file their return early the following year.
It is, basically, but there are quirks in the projection. The one that confuses many people, and makes them think they are paying more tax than they actually end up paying, is that if you get a bonus (or do a bunch of overtime) one pay period, the system does not know that is a “one off”. Your taxes are withheld as if you earned that amount every pay period. Hence you may well be taxed at a higher rate, but will get the excess tax back when you submit your tax return.
The other issue is that Saint Cad’s “projected AGI” includes things like deductions. So the tables have to take a WAG about how much deduction there will be.
e.g. For somebody earning $20K / year it’s pretty clear they’ll be taking the standard deduction since they can’t afford a mortgage that would generate enough interest to itemize. And they’re probably not funding an IRA the full 5K.
With somebody making $100K / year it’s more plausible to assume they’ve got deductions above the standard and may be funding an IRA.
The Pub 15 process also assumes the taxpayer is working for only one employer at a time, only one all year, and at a constant pay amount per pay period.
Etc. All of which simplifying assumptions fit many people, but not all.
The worksheet that comes with the W-4 gives the taxpayer the opportunity to fine-tune the withholding to match his/her expected income / deduction / exemption profile by computing a number of “allowances” that, once claimed, can increase or decrease the withholding.
Many modern payroll systems can handle large extra payments by applying a flat tax rate to that payment only. The result is that the payroll system doesn’t over-tax regular pay for the rest of the year based on that one large extra payment.
This really isn’t true. About 40% of Americans use the 1040EZ (half a page, takes 10 minutes) or the slightly more onerous 1040A. The vast majority of people who earn wages and don’t have significant investment income and are not self-employed take the standard deduction.
*Nina Olson, the National Taxpayer Advocate estimates that almost 60 percent of filers will pay someone to prepare their returns this year, while 30 percent will use specialized software to help out. *
Just because someone uses 1040EZ does not necessarily mean they complete it themselves.
You are correct that my ex-pat status adds to the complexity. Six of my 28 pages were for form 8938, Statement of Foreign Assets.
But that’s not necessarily because of complexity; it can just be an insecurity with the whole process. Or if you get your taxes filed for you, the company gives you a loan against your refund.
I don’t think he meant that it the increased withholding spills over into the other pay periods. He just said that if increased your withholding THIS month, as if you were going to make that much money in all the other months, but then NEXT month when your pay goes back to normal the withholding also goes back to normal. The result is that you slightly overpaid that one month, which is no big deal in the big scheme of things.
Remember, the IRS doesn’t want your withholding to be exactly equal to the tax you owe. On the contrary, what they want is for you withholding to be HIGHER than what you actually owe, so you get a refund. This accomplishes three goals. First, it gives you an incentive to file your return. Second, it takes the sting out of paying thousands of dollars by creating the illusion that your getting a bonus of a few hundred dollars. Third, it means the government got to use your refund money interest-free.
*Nina Olson, the National Taxpayer Advocate estimates that almost 60 percent of filers will pay someone to prepare their returns this year, while 30 percent will use specialized software to help out. *
Just because someone uses 1040EZ does not necessarily mean they complete it themselves.[/QUOTE
The vast majority of EZ filers who use a paid preparer are doing it to get a loan against their refund. In my experience at least. I was a volunteer preparer, and many people would walk away upon discovering that they would need to wait a few weeks for their refund if they used our free service. They seemed to be utterly unaware that what they were getting from Dewey Cheatham and Howe was a loan and not an instant refund from the IRS, and that they were giving up 10 to 25% to get the money a few weeks earlier.