How to Calculate Income Tax for an Employee

1). Gather the necessary information to figure federal income tax. You will need the employee's filing status and number of allowances (W-4 form) and the IRS withholding tax tables (Circular E) to determine the tax. The IRS sends all employers it has on file a Circular E each year with the updated tax tables. If you do not have a copy, retrieve it online via the IRS' website.
2). Calculate federal income tax using the Circular E's wage bracket method or the percentage alternative.

Use the wage bracket method if the employee's income is within the income range and if he has fewer than 10 allowances. For instance, say the employee earns $660 weekly and claims single/three. According to page 41 of the 2010 Circular E, his weekly federal income tax withholding would be $47.

Use the percentage method under any circumstance. For instance, say the employee earns $740 weekly and claims single/three. Go to page 37 and calculate: $740 - $210.57 ($70.19 x 3) = $529.43. Go to page 39 and calculate: Excess over $200 = 329.43 + 15 percent = $49.41 + $8.40 = $57.81, weekly federal income tax withholding.
3). Use the employee's state tax form---which depicts her filing status and number of allowances---and the state withholding tax tables to determine the state income tax amount. State income tax rates vary by state. Retrieve the tax tables online or contact your local Department of Revenue for the tax rate. Some states (for example, Tennessee, Wyoming and Texas) do not impose this tax.
4). Figure Medicare tax at 1.45 percent of all gross income. For instance, say the employee earns $800 biweekly. Calculation: $800 x .0145 = $11.60, biweekly Medicare tax.
5). Calculate Social Security tax at 6.2 percent of the employee's gross compensation up to the annual wage base of $106,800.

For instance, say the employee earns $1,200 biweekly. Calculation: $1,200 x .062 = $74.40, biweekly Social Security tax.

Once the employee reaches the yearly wage limit, stop the Social Security withholding. Start it back up at the beginning of the next year.