1. Smoothing Formula:
The smoothing formula calculates the tax for an employee in two (2) stages:
1st Stage: Regular Payments: Broadly, the tax on the regular payments is calculated by first finding an estimate for total taxable pay for the whole year, taking into account what has been paid before. It then
- calculates the tax payable on that amount;
- subtracts the tax already paid;
- pro-rates the remaining tax for the current cycle, based on the regular payments this cycle versus the regular payments estimated for the rest of the year.
2nd Stage: Irregular Payments
- The tax on the irregular payments is found by simply multiplying the payments by the employee’s highest marginal rate.
2. Smoothing Formula 2:
This formula is similar to the Smoothing Formula with the following exceptions:
- it uses overtime and irregular income and allowances (irregular taxable pay) to determine the marginal rate.
- Also, if the irregular pay carries the employee over into a positive marginal rate then the irregular amount in excess of the tax allowances is taxed at this marginal rate.
So, using the Smoothing Formula 2, the employee’s regular taxable earnings AND his non-regular taxable earnings are used to project what he would earn for the year.
Example - Smoothing Formula
Notice that in the Smoothing Formula, the employee is not taxed even though his non-regular taxable carries him over the personal allowance.
Tax Threshold: the amount of income below which you do not have to pay income tax.
Marginal Tax Rate: the tax rate for the highest tax bracket to which an employee belongs e.g. in Barbados, an employee earning $100,000 a year with a tax allowance of $15,000 will be in the 40% bracket, so his highest marginal rate is 0.4. An employee earning $30,000 a year with a tax allowance of $15,000 will not cross the $24,200 barrier, and thus belongs to the 25% bracket. Thus his highest marginal rate is 0.25
Example - Smoothing Formula 2
Notice that the Smoothing Formula 2 does, in fact, tax the employee and deducts tax in the cycle in which the non-regular payment is being made.
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