How does the Smoothing Formula work?
The Smoothing Formula is one of the tax calculation methods that is used to calculate taxes (P.A.Y.E.) in the POWERpay Payroll. This formula is best applicable to pay groups with employees who meet the following criteria:
- The employees generally will work all year round, excluding vacation periods.
- The Cycle Rate on the Employee Pay Profile screen is a good estimate of what the employee will make in regular earnings (straight time or basic salary) each cycle.
Most monthly-paid payrolls meet the above criteria, and it is advised that users use this smoothing formula for such groups because:
- The taxes at the end of the year are usually correct so that the employees do not owe any taxes.
- The tax burden each cycle is fairly regular, so that employees can expect a fairly regular net pay and so can prepare their personal budgets with some confidence.
- Irregular pay such as overtime, bonuses, one-off allowances etc. are taxed immediately and fully, so that the taxes on such payments do not extend over a period of time, which can be burdensome to some employees.
The above assumes that pay will be fairly regular for the whole year, and when the system spreads taxes, it assumes that there will be enough pay to cover those taxes.
For employees, however, whose gross pay for the cycle is less than the quoted cycle rate e.g. an employee only made 10% of his quoted cycle rate (say he was suspended, or on no pay leave), then the calculated tax will probably be MORE than his gross for the cycle. In such a case the Smoothing Formula performs a pro rationing of the tax to be paid:
- YTDs for earnings, allowances, other income and tax paid are taken into account.
- An estimate of future earnings using regular payments for the current cycle, and estimate tax to be paid for the whole year are made.
- Instead of evenly distributing the tax remaining to be paid over future cycles, the system takes a portion of that tax based on the ration (Regular Payments this Cycle)/(Estimated Regular Payments for Rest of year including this cycle). This ration is the proportion of regular payments he has made this cycle out of what he is expected to make for the rest of the year. Therefore, this should also be the proportion of tax to be paid in this cycle out of tax remaining to be paid. The system then taxes any non-regular income at the employee’s highest marginal rate.
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