Greenshades Payroll supports two different tax calculation methods that can be used to calculate tax withholding on employee regular wages. Each method is allowed by IRS publications and are simply different ways of calculating tax: 

Greenshades' default calculation method is the Annualized Calculation method, which uses the gross wages on each individual check alongside the number of pay periods in the year in order to estimate the employee's annual wages and therefore the tax on those annual wages. In other words, the Annualized Calculation Method assumes that the current earnings are typical for the employee in question.

The alternate method is the Cumulative Calculation method, which looks at the total pay received during the year in order to estimate what tax is appropriate on all earnings. In other words, the Cumulative Calculation Method does not assume that the current check is typical for the employee in question, and thinks that the employee's total year-to-date pay is a better indicator to drive withholding calculations. 

The Cumulative Calculation method is frequently preferred for employees that do not consistently have the same amount of regular earnings each pay period, such as commission salespeople or employees that get large but infrequent regular-pay bonuses. 

Both methods are described in detail below, along with examples. 

Annualized Calculation Method

The annualized calculation method is the most common  method for Greenshades Payroll calculating withholding on regular wages. The gross wages are first multiplied by the number of pay periods in the year to get the employee's annual wages. The annual tax amount is the calculated on the annual wages. Finally, the annual tax is divided by the number of pay periods to get the tax amount for the current payroll. This is also commonly referred to as the percentage method of withholding (or, less commonly, as the computer formula method). IRS Publication 15-T refers to it as the Percentage Method for Automated Payroll Systems. Note that Greenshades uses the annualized percentage method, not the wage bracket method. The wage bracket method described in 15-T is intended for manual payroll processes, not intended for payroll software such as Greenshades Payroll.

The Annualized Calculation Method is the default method used by nearly every piece of payroll software and is likely how your employees are accustomed to their withholding being calculated. 

Greenshades uses the pay period to determine the number of pay periods per year, as follows:

 

Pay Frequency	Pay Periods per Year
Annually	1
Semi-Annually	2
Quarterly	4
Monthly	12
Semi-Monthly	24
Bi-Weekly	26
Bi-Weekly (with extra pay period)	27
Weekly	52
Weekly (with extra pay period)	53

Example of a Bi-Weekly Payroll using Annualized Calculation Method
 

In the following example, an employee working in Albuquerque, New Mexico, earns regular wages of $3,456 per pay period. They are paid every two weeks (26 pay periods).

For this payroll, we will set up the $3,456 as regular wages.

Greenshades will multiply the current wages by the number of pay periods to find the employee's annual wages:

• $3,456 x 26 pay periods = $89,856

Greenshades will then calculate the tax on the annual wages

• Annual federal income tax = $12,536.32
• Annual state income tax = $3,806.17

Divide the annual tax by the number of pay periods to determine the current withholding amount 

• Federal income tax = $12,536.32 / 26 = $482.17
• State income tax = $3,806.17 / 26 = $146.39

 

Cumulative Calculation Method

The cumulative calculation method for Greenshades Payroll will use the total amount of wages paid to the employee during the calendar year in order to calculate tax withholding. This is frequently preferred for employees who have inconsistent or "lumpy" earnings throughout the year, such as a salesperson who occasionally has large commission earnings or an employee who is getting infrequent but large bonuses that are categorized as a regular earning type.

In order to use the Cumulative Calculation Method, you must check the appropriate option on the employee card that will mark this employee to receive this calculation method. You must ensure that the employee has requested this option in writing. It is your responsibility to ensure you have this request documented in writing before activating this option: Greenshades will not track the documentation requests on your behalf. 

This calculation method is also described in IRS publication 15-T.  

 

Example Calculation of an Abnormally Large Check using the Cumulative Calculation Method

Payroll period #1
In the following example, a commission-based employee working in Albuquerque, New Mexico, earns regular wages of $1,234 in the first pay period of the year. They are paid every two weeks (26 pay periods).

For the first payroll, our employee earns $1,234 in regular wages. 

Greenshades will calculate tax withholding as follows:

• Add the year-to-date wages to the current pay period wages
  • $0 year-to-date wages + $1,234 current wages = $1,234
• Divide by the number of pay periods so far this year, including the current period
  • $1,234 / 1 = $1,234
• Calculate the withholding on $1,234
  • Federal = $80.41
  • State = $37.51
• Multiply by the number of pay periods so far this year, including the current period
  • Federal = $80.41 x 1 = $80.41
  • State = $37.51 x 1 = $37.51
• Subtract the year-to-date withholding to determine the amount to withhold for the current pay period
  • Federal income tax = $80.41 - $0 = $80.41
  • State income tax = $37.51 - $0 = $37.51

Payroll period #2
For the second pay period of the year, the employee earns double their normal amount: $3,456. This serves to showcase an example of what happens when an employee receives a larger earning that is not part of their typical check.  

Greenshades will calculate tax withholding as follows:

• Add the year-to-date wages to the current pay period wages
  • $1,234 year-to-date wages + $3,210 current wages = $4,444
• Divide by the number of pay periods so far this year, including the current period
  • $4,444 / 2 = $2,222
• Calculate the withholding on $2,222
  • Federal = $210.686153 (pre-rounding)
  • State = $85.925115 (pre-rounding)
• Multiply by the number of pay periods so far this year, including the current period
  • Federal = $210.686153 x 2 = $421.372306
  • State = $85.925115 x 2 = $171.85023
• Subtract the year-to-date withholding and round the result to determine the amount to withhold for the current pay period
  • Federal income tax = $421.372306 - $80.41 = $340.96
  • State income tax = $171.85023 - $37.51 = $134.34

 

The employee ends up with a lower tax withholding amount on these checks when compared to the Annualized Calculation Method. This is because the Cumulative Calculation Method will look at all YTD earnings for the employee before determining withholding, while the Annualized Calculation Method would calculate tax withholding assuming that the current check is a standard earning for this employee.

 

Side-by-Side Example of Annualized Withholding Method vs. Cumulative Withholding Method 

Finally, consider the case of an employee who earns $5,000 of gross wages each bi-weekly pay period. However, on the 12th pay period of the year, the employee in question receives a $30,000 bonus with the bonus classified as regular earnings (See the KB article on taxability of bonus payments for other ways to classify a bonus).  

Using the Annualized method, Greenshades will calculate the withholding on this $35,000 of gross earnings as if this is a typical paycheck for the employee.  Using the Cumulative Withholding Method, Greenshades will calculate the withholding on the basis of this check as well as the prior 11 checks. The Cumulative Withholding Method "smooths out" this one-time bonus to generate a withholding that is likely more appropriate for this scenario.