Why is tax withholding based on the current paycheck only and not cumulative?

Question

This question points out the familiar but bizarre mechanism that tax withholding uses: every paycheck is extrapolated to the year, tax is computed on that amount, and tax is withheld for the fraction of the year that the pay period covers. Bonuses, for example, may receive very high withholding, leading to excess tax being withheld and returned to the recipient far in the future.

On the other hand tax could be withheld based on cumulative income on the cumulative pay period. That is, starting at the start of the year or the start of payroll within the year, each pay period adds to the cumulative pay period and each paycheck adds to the cumulative income. The cumulative income is extrapolated to the year based on the cumulative pay period, as is currently done with a single paycheck and a single pay period, to compute an estimated income. The estimated income gives an estimated annual tax, which is scaled down to the fraction of the year that the cumulative pay period covers to determine a cumulative tax amount. The amount withheld from your paycheck is the cumulative tax amount amount minus the cumulative withholding in all previous pay periods.

The result of this scheme is withholding goes up and down to target the correct tax rate throughout the year. If you get a bonus it averages in with your past paychecks, and future pay checks further smooth it out.

Is there any reason why withholding is so primitive and doesn't use a cumulative method like the one described above?

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There's been some confusion about the cumulative scheme above. Say you are paid every 2 weeks. The tax scheme is 25% of income from $50k to $100k and 50% of your income above $100k. In the first pay period you get paid $3k, in the second $5k, and in the third $4k.

status quo

paycheck 1:

• paycheck: $3k
• estimated income: $3k * 26 = $78k
• estimated tax: $7k
• withholding: $7k / 26 = $269

paycheck 2:

• paycheck: $5k
• estimated income: $5k * 26 = $130k
• estimated tax: $27,500
• withholding: $27,500 / 26 = $1058

paycheck 3:

• paycheck: $4k
• estimated income: $4k * 26 = $65k
• estimated tax: $14,500
• withholding: $14,500 / 26 = $558

total paid: $1,885

cumulative

paycheck 1:

• cumulative pay period: 2 weeks
• cumulative income: $3k
• estimated income: $3k * 26 = $78k
• estimated tax: $7k
• cumulative tax: $7k / 26 = $269
• withholding from this paycheck: $269

paycheck 2:

• cumulative pay period: 4 weeks
• cumulative income: $8k
• estimated income: $8k * (26/2) = $104k
• estimated tax: $14,500
• cumulative tax: $14,500 / (26/2) = $1,115
• withholding from this paycheck: $1,115 - $269 = $846

paycheck 3:

• cumulative pay period: 6 weeks
• cumulative income: $12,000
• estimated income: $12,000 * (26/3) = $104k
• estimated tax: $14,500
• cumulative tax: $14,500 / (26/3) = $1,673
• withholding from this paycheck: $1,673 - $1,115 = $558

total paid: $1,673

Answer 1

To reuse an answer from software engineering, the reason it doesn't work that way is because no one has decided that it's worth the time, money, and effort to design, implement, test, deploy, and support a complete overhaul of the payroll deduction system to use year-to-date salary as the basis. It would still need to handle situations like multiple incomes (either one person with two jobs or two with one job each), changes in employer, different filing statuses, different levels of itemized deductions, etc., etc.

Also, what would happen if you have a drop in income one period so that the formula results in a credit to you? Would your employer then have to add to your paycheck to restore the balance? These types of scenarios make ANY system imprecise.

The current system is simple, easy to implement, and can be manually "tweaked" (via the number of allowances) to account for different situations. I don't see a huge benefit by making it ultra-precise on a year-to-date basis when all that really matters is your total income for the year, your deductions, and how much was withheld. It's not perfect, but the marginal benefit is likely not worth the cost.

Answer 2

A strict "cumulative method" would result in no tax withheld for the first few months of the year and lots of tax withheld in the last few months as you cumulatively move up into higher tax brackets. Many people would rather spread those tax payments equally among all pay periods and receive roughly the same paycheck each month.

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Based on your comment, it sounds like you are talking about having the first paycheck calculated based on the current method, but each subsequent paycheck would adjust slightly in an attempt to more accurately withhold the correct amount. The problem with this is that even if the employer does this, it won't necessarily be more accurate.

Tax withholding is only at best a rough estimate. This is because there is so much information that goes into your tax calculation on your return that your employer doesn't know. You don't even know all this information until the end of the year. And it varies greatly from person to person and from year to year. An attempt to be more accurate using your method would not necessarily get you any closer to a zero refund/zero tax due; it would be just as likely to move you further away from the target.

Instead, if you want to be more accurate, you can monitor the situation yourself and adjust your tax witholdings using the W-4 form. The IRS has a withholding calculator that allows you to input your current situation and tells you how to adjust your W-4 form to be more accurate. Ultimately, you are in charge of the amount of tax withheld from your paycheck, not your employer.

Answer 3

As others have noted it doesn't work for people who have more than one job, or are married and both work, or change jobs.

Is there any reason why withholding is so primitive and doesn't use a cumulative method like the one described above?

The current system is easy for the employer to calculate. The tables/formulas are simple. You don't need a computer to make the calculation. The one you are proposing need to know the cumulative numbers, and do complex calculations; and still have problems because the employer doesn't know about the rest of your financial picture.

Answer 4

It's worth noting that, at least in the US as of 2024, this is in fact a method that is approved by the IRS, though only upon the employee's written request. See IRS Pub 15-T, alternative methods for figuring withholding, cumulative wages: https://www.irs.gov/publications/p15t#en_US_2024_publink100021821

Cumulative wages. An employee may ask you, in writing, to withhold tax on cumulative wages. If you agree to do so, and you’ve paid the employee for the same kind of payroll period (weekly, biweekly, etc.) since the beginning of the year, you may figure the tax as follows.

Add the wages you’ve paid the employee for the current calendar year to the current payroll period amount. Divide this amount by the number of payroll periods so far this year, including the current period. Figure the withholding on this amount, and multiply the withholding by the number of payroll periods so far this year, including the current period. Subtract the total tax already deducted and withheld during the calendar year from the total amount of tax calculated. The excess is the amount to withhold for the current payroll period. See Revenue Procedure 78-8, 1978-1 C.B. 562, for an example of the cumulative method.

As to why this isn't the default: I'm assuming the inertia behind the existing methods, as pointed out in the other answers.

Why it's only allowed upon the employee's request (as opposed to being the employer's discretion) I do not know.