This is one of the most frequently asked questions from customers who use our Paycheck Manager online payroll software. When a customer sees $0 for Federal income tax (no withholding), it may appear like something is wrong with the online payroll tax calculations.
However, the short answer is “No”, there is nothing wrong with the paycheck calculation.
The calculated income tax, for Fed or State, is an “Estimate” of the tax liability of the employee, and is based on the W-4 conditions, Pay cycle and the Gross earning amount of the paycheck. Depending on the W-4 conditions, an employee may have more or less tax liability.
Let us use the following example to explain how the payroll taxes are calculated.
- Company pays employees every week (Pay cycle is “Weekly”)
- An employee worked 40 hours at $15/hour for this paycheck (Gross earning is $600)
- The employee W-4 marital status is “Married”.
- The employee has 1 dependent under the age 17.
Step 1: Estimated annual earning = $600 x 52 weeks = $31,200
The calculation does not and can’t consider variations in prior paychecks or future earnings for the estimated annual earnings (employee could get a big raise or lose the job).
Step 2: Taxable income = $31.200 – $25,100 = $6,100
Annual earning minus the Standard Deduction for a married couple ($25,100 for 2021).
Step 3: Estimated income tax = $610 (10% tax rate for taxable income of $6,100, divided by 52 weeks = $11.73 per check)
Income tax is calculated based on IRS tax tables & rules.
Step 4: Child tax credit = $2,000/52 week = $38.46 per check
For each child under 17, the taxpayer can receive a $2,000 child tax credit per year. Instead of receiving the credit when filing 1040 tax return, the credit is calculated and deducted from the estimated income tax on every check.
Since the child tax credit ($38.46) is more than the estimated tax liability ($11.73), the income tax withholding will be $0. The calculation is accurate. There is no need to withhold income tax because there will be no tax liability based on the conditions used for the paycheck.
There are many options for an employee to change their tax withholding calculations. An employee can choose not to claim the child tax credit on the paycheck and receive the credit when filing their 1040 tax return instead by choosing “0” for child under 17. An employee can also choose their filing status as “Single” to withholding more taxes when the paycheck is calculated.
In Paycheck Manager’s online paycheck calculator, there are many more options beyond the above by accessing the “Show more options” and entering in a manual amount under “additional withholding”. The entered amount does not change the employee’s actual tax liabilities, but will deduct more from their paycheck, and in turn, change the amount of their tax refund or taxes owed when filing their 1040 tax return.
You can easily play around with different payroll tax calculations with our FREE Paycheck Calculator. We provide a trusted payroll tax calculator to help you figure out the best payroll tax withholding for your situation.