Payroll Processing: Standards Don’t Always Fit All

Payroll processing can be very complicated.  New employees often run into problems with their federal withholding. Unfortunately, they do not notice this issue until they go to file their income tax returns.

It would be easy to suggest to employees that they pay attention to their pay stubs.  However, there are many different withholding amounts on them, so even the pay stub becomes very confusing to people.

Employees are requested to fill out a Form W-4 when they are hired in, but that can be complicated as well.  It is also difficult to assist employees with Form W-4 because it requires some basic understanding of their personal finances. 

One could argue that this should have been noticed by those preparing payroll.  However, this is not the case. Payroll processing departments (payroll companies), only have the Form W-4 to refer to.

The problem is that this is one standard payroll withholding table that is designed to fit all. But the U.S. tax system is not this straightforward.  If you were to looks at 10 tax returns, all with total income of $50,000, you will likely see that every return has a different tax amount.

The U.S. tax system provides us with different benefits depending on our situation.  Those with total income of $50,000 can all have a variety of different circumstances that the Form W-4 just does not alert us to.  

• One could file single; another could file a joint return.
• One employee could have a spouse who does not work; another household could have two working taxpayers.
• One employee could have zero kids; one could have five.
• One may have daycare expenses.
• One could own a house with a mortgage and property taxes; one may rent a home.
• One employee may contribute to a retirement plan; another may choose to not contribute to a retirement plan.

All of these factors above can change one’s tax liability. All have the same income, but definitely different tax liabilities and refund.  

Unfortunately, as employers, you do not know most of these circumstances. Incorrect payroll withholding on a W-4 is not a mistake by the employer.  It is not the employer’s fault, and employer should not feel that they should compensate staff for these shortfalls.  

Having them revise their Form W-4 is the best advice you can give them.  Step 4(c) of Form W-4 is where an employee can correct the problem moving forward.  The best suggestion is to advise them to minimally take the amount they owed on their tax return, divide it by the remaining pay periods for the current year, and then write that number on line 4(c ). If they do not make this adjustment, then they will likely owe a similar amount the following year.

• Example 1:  If they owed $1,500 and there are 26 pay periods remaining, then the line 4 amount would be $57.70.
• Example 2: If they owed $1,500 and there are 20 pay periods remaining, then the line 4 amount would be $75.00.

There is no way to predict if the W-4 an employee provided is correct or incorrect. It is not the employer’s fault. However, showing them how to complete the W-4 properly once they do recognize their own oversight can help.