Though payroll is an integral part of the functional schema of all the organizations, not many hold a mastery over the task itself. Complex and ever-expanding nitty-gritties of payroll are complex enough to bewilder a person. It is perfectly reflected in the fact that almost 33% of employers are paying billions of dollars in fines each year due to payroll processing errors. And the majority of fines are due to incorrect payments made to employees. Before you run a payroll system, thus, it's of utmost importance to understand taxable wages and ways of calculating them.
The Meaning of Taxable Wages:
Taxable Wages, in payroll, is the sum of all earnings by an employee that are eligible for a particular type of tax. Each tax is different and has different regulations about limits to the amount of wages that can be considered taxable with respect to that tax. Some examples of taxable wages include salaries, hourly wages, bonuses, and commissions. As an employer, you are responsible for deducting and remitting taxes from employee paychecks.
How to Calculate Taxable Wages?
For the sake of understanding, we will be calculating the taxable gross for Federal income tax. Note that taxable gross varies depending on tax type. The formula will further simplify the task.
Taxable Gross = Gross – Nontaxable Earnings – Pretax Deductions + Taxable Benefits
The following data has been taken from a sample pay stub:
- Earnings— Salary Wages: 1500.00, Mileage: 18.35
- Employee Deductions— Health: 45.29, 401k: 40.69
- Employer Paid Benefits— Travel Allowance: 25.00
A) Calculate the Gross Wages:
This should be the total income before taxes and deductions are withheld.
1500 + 18.35 = 1518.35
B) Deduct Non-Taxable Wages:
It’s important to know that not all wages are taxable. They need to be deducted from the calculation of taxable gross. The best way to do it is to subtract them from gross wages.
1518.35 – 18.35 = 1500.00
C) Bring in Pretax Deductions:
Prior to calculating taxes, pretax deductions should be deducted. If any of this applies, subtract the amounts withheld from your gross wages.
1500.00 – 45.29 - 40.69 = 1414.02
D) Add Employer-Provided Benefits:
If there are any employer-provided taxable benefits, they should be added to the result above in step 3.
1414.02 + 25.00 = 1439.02
The result above denotes your exact taxable wages. The same calculation would get applied for each type of tax applicable to the employee before applying the tax calculation for the employee’s withholding amounts.
Things to Look at While Considering Taxable Wages:
A) Taxable Wage Base:
The taxable wage base is the maximum amount of wages employees must pay taxes on. Once an employee earns more than the wage base set by the government, he or she does not pay taxes. The Social Security wage base is the highest amount of income that can be taxed for Social Security. The 2017 Social Security wage base is $127,200. The 2018 wage base is $128,400.
B) State-Based Wages:
Even if some wages fall above federal wage bases, they may be subject to taxes. Certain states may set their own wage bases – and they can be higher than federal wage bases. Employees have to pay taxes until their wages exceed the higher wage base.
C) Nontaxable Income:
Most of the wages that you pay to employees are taxable. But some compensations don’t fall under the ambit of taxation. Generally, they include business expense reimbursements, certain non-cash holiday gifts for employees (e.g., gift vouchers during holidays), and cash advances or loans. If you aren’t sure about nontaxable wages, it’s always advisable to consult a tax expert.