Types

• The federal government requires you to withhold federal income tax, Social Security tax and Medicare tax from all employees’ paychecks, unless an exception applies. Most states mandate employers withhold state income tax as well. Some local governments require local income tax withholding, such as city income tax or school district tax. The Internal Revenue Service collects federal taxes, and the state revenue agency collects state income tax, and in some cases, local income tax; otherwise, the local tax assessor administrates local income tax. In rare cases, such as Alaska, Pennsylvania and New Jersey, an employer must also withhold state unemployment tax from employees’ paychecks.
  
  

Exceptions

• Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Tennessee, Washington and Wyoming do not charge employees state income tax. In addition, if an employee meets federal or state requirements for exemption from withholding, you are not required to withhold the respective tax from their paychecks. Federal income tax, and in many cases, state income tax, is collectively based on an employee’s wages, filing status and allowances. If the employee claims many allowances or if her income is below a certain amount, it can exempt income tax withholding.
  
  

Calculation

• To withhold federal income tax, obtain the employee’s filing status and allowances from lines 3 and 5 of his W-4 form, and apply the IRS Circular E’s tax withholding table that matches that information plus the employee’s wages and pay period. To figure out state and local income tax, follow the administering agency’s requirements. Many states use a withholding system comparable to federal income tax withholding. As of September 2011, withhold Social Security tax at 4.2 percent of wages paid to each employee up to $106,800 for the year per employee, and Medicare tax at 1.45 percent of all wages paid. If applicable, apply the state unemployment agency’s rules to withhold state unemployment tax.
  
  

Warning

• The penalties for failure to withhold, remit and report taxes to the administering agency can be severe. Penalties include audits by the agency, late filing and deposit penalties, interest, liens or levies attached to the employer’s property, criminal investigation and the employer being referred for prosecution.