Identification

• Wages subject to federal tax withholding include all pay an employer gives to its employees for services rendered. Remuneration can be in the form of cash or otherwise, such as check or direct deposit. Wages include salaries, bonuses, commissions, overtime, vacation allowances and fringe benefits. Under federal law, employers are required to withhold federal income tax, Social Security tax and Medicare tax from employee wages.
  
  

Significance

• Federal employment taxes on wages are used to fund federal and national programs. The Current Tax Payment Act of 1943 legalized federal income tax withholding so the U.S. government could fund the national welfare system. Federal income tax also provides for law enforcement, community development, interest on national debt and foreign affairs.
  
  Social Security and Medicare taxes make up the Federal Insurance Contributions Act, which grants the IRS the authority to collect these taxes. Social Security provides benefits to retirees, the disabled, beneficiaries of deceased employees and the dependents of beneficiaries. Medicare provides medical and hospital insurance to qualified individuals when they reach age 65 and the disabled.
  
  

Calculations

• An employee's federal income tax withholding is based on the filing status and allowances she claims on her W-4 form and the IRS Circular E withholding tax table that matches her filing status, allowances, wages and pay period. Social Security and Medicare taxes are withheld at the flat percentages the government sets annually. In 2011, an employer calculates Social Security tax at 4.2 percent of an employee's taxable wages, up to $106,800 for the year, and Medicare tax at 1.45 percent of all taxable wages.
  
  

Pretax Deductions

• An employer should consider whether an employee has qualifying pretax deductions before withholding federal taxes from his wages. For example, traditional 401(k) plan contributions are subject to FICA tax withholding, but not federal income tax withholding. Section 125 -- or cafeteria -- plans are not subject to FICA taxes or federal income tax. When a qualifying pretax deduction applies, the employer subtracts it from the employee's gross income before withholding the tax, thus lowering the employee's taxable wages.
  
  

Considerations

• An employer pays the federal taxes it withholds from wages to the IRS, usually semiweekly or monthly. It files tax returns quarterly to report its federal tax liabilities; if the payroll is small, the IRS may allow the employer to file yearly. It files annual W-2s with the Social Security Administration to report the employee's yearly wages paid and taxes withheld.
  
  

Warning

• Noncompliance with federal tax withholding laws can lead to the employer facing audits, liens, levies, deposit penalties, failure to file and failure to pay penalties, interest, and in the case of willful violations, criminal prosecution and imprisonment.