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

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?

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

• So in your example there is a \$1 withholding difference over the 3 pay periods? Doesn't that seem like an argument for not fussing with changing it? – Hart CO Apr 16 '18 at 21:28
• In looking over your example, I wouldn't be surprised if many payroll systems use the method you describe to determined annualized income for hourly/variable hour employees. I thought you were referring to a 'withhold as you earn method' where so far you've earned < \$15,000 so you're in the 10% bracket, ooo now you're at \$30k now you're in the 20% bracket etc. – quid Apr 16 '18 at 21:44
• I think your example would be better if the end result was more than \$1 difference after 3 paychecks. And paycheck 2 being identical is a funny coincidence. – TTT Apr 16 '18 at 21:56
• My initial example was a mistake as all paychecks were in the same bracket and so the numbers came out the same. I updated the example to one with paychecks in different brackets. Now the numbers are different. – Reinstate Monica Apr 17 '18 at 0:27
• Over here (Germany - thus only a comment) employers must follow the tax withholding calculations prescribed in detail by tax law. I think your proposal is close to our "permanenter Lohnsteuer-Jahresausgleich" (≈ ongoing annual balancing of tax withholdings). This is possible under certain circumstances listed in the income tax law on request to the tax office. Once-only bonus payments (as opposed to variable parts of the regular wage) enter the projected annual income as once-only by law (they are often paid in November or December, so the correct annual wage is basically known anyways). – cbeleites unhappy with SX Apr 17 '18 at 14:01

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.

• This is a good answer. The year-to-date method is a change from the status quo, and could require a credit, and in practice probably only noticeably benefits people who get large bonuses or raises. – Reinstate Monica Apr 17 '18 at 0:29
• "It would still need to handle situations like multiple incomes (either one person with two jobs or two with one job each)" As far as I know, no payroll system does this ,which is why people with two jobs might fill out their W4s differently to account for that, or like my wife and I who fill out our W4s to have more tax withheld. – Andy Apr 17 '18 at 0:39
• @Andy I was including the W-4 and calculation of exemptions as part of the "system". That's where multiple incomes and filing status are taken into account. – D Stanley Apr 17 '18 at 13:23
• The interesting question from my German perspective is: besides being (not) worth the effort, would it be legally possible? (Over here tax law prescribes in detail how the withholdings must be calculated - including that for multiple incomes in parallel, only one gets the usual tax brackets, the others are subject to heavy withholding rates) – cbeleites unhappy with SX Apr 17 '18 at 14:58
• In the UK, it is actually possible to get credit (often after a period of unemployment). Your employer might pay your salary plus £1,000 in tax, obviously tell HMRC about it, and pay £1,000 less income tax to HMRC in that month. On the other hand, if you have an extra good month, no more than 50% of your salary can be taken as tax. – gnasher729 Apr 17 '18 at 21:58

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.

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.

• I think you misunderstand. Your first paycheck would be withheld as the current method does. Assuming equal pay periods, the second would be withheld based on the tax rate at the average of the two paychecks on the cumulative period minus withholding so far. So you certainly would pay tax at the beginning of the year. And if all paychecks and pay periods are equal, the same amount would be withheld from each. – Reinstate Monica Apr 16 '18 at 19:33
• Exactly. And the flow into the government would be backloaded in a way that would be “bad”. – JTP - Apologise to Monica Apr 16 '18 at 19:34

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.

• Single paycheck or cumulative are the same re: multiple incomes. Neither single nor cumulative is calculated by hand and both are roughly as simple to program. – Reinstate Monica Apr 16 '18 at 20:01
• @Solomonoff'sSecret But your proposal would be worse that the current system for multiple incomes (or changes in income sources). At least now you can change the exemptions between pay sources to get close to the average needed to be withheld. It would be much more complex to do that in a system that required all income from the beginning of the year. – D Stanley Apr 16 '18 at 21:12