Have you ever wondered what’s coming out of your paycheck every week? Your employer is withholding taxes from your paycheck, but how are those taxes calculated? This handy guide will breakdown what’s exactly coming out of your paycheck and help you understand where your money is going.
In the 1930s, the New Deal introduced Social Security – a social welfare program for the retired or disabled. To pay for this expansive new plan, congress enacted the Federal Insurance Contributions Act (more commonly know as FICA).
The FICA tax is comprised of two distinct taxes, Social Security Tax and Medicare Tax. These two taxes are commonly shown as two separate lines on your paycheck and take up a considerable amount of take-home pay.
For 2018 the Social Security tax rate is 6.2% on the first $128,400 of wages and the Medicare tax rate is 1.45% and is not subject to any caps. Combined, FICA taxes can eat up as much as 7.65% of your paycheck.
Federal Withholding Tax
Another tax that takes a big bite out of your paycheck is your federal income tax withholding. This is the same tax you pay in April when you file your federal income tax return. Pay too much during the year and you’ll get a nice refund, pay too little during the year and you’ll owe Uncle Sam.
To determine how much tax should be withheld from your pay you’ll have to fill out the Form-W4. Your employer will provide this form to you when you’re first hired and you’ll have to choose a filing status (single or married) and the number of exemptions you are claiming.
The payroll department will then use your W4 to calculate how much withholding should be taken out based on a variety of factors, such as:
- Payroll frequency (weekly, bi-weekly, semi-monthly, etc).
- Marital Status
- Number of allowances
- Gross wages subject to withholding.
As shown by the charts above, there are several factors that change your federal withholding and there are several tables your payroll department will have to keep track of. To keep it simple, the more exemptions you claim the less tax will be withheld from your paycheck. However, the tax that is being withheld from your pay will impact your refund or the amount of tax you owe at the end of the year.
State and Local Taxes
Depending on where you live you will see a variety of taxes being withheld from your paycheck. If you are lucky enough to live in a state with no state or local income tax then you won’t see anything being withheld on your pay when it comes to your state. If you work in big cities like NYC then expect to see a considerable amount of dollars being drained from your pay.
- State Income Tax – Works the same way as Federal Income tax but on a state by state basis.
- City Income Tax – For some localities you’ll have to pay income tax to the city as well. Talk about a triple whammy!
- Disability Insurance – Some states require workers to pay into a disability insurance program. If you become disabled and cannot work you may receive disability payments from the state.
- Family Leave Insurance – In several states there are programs that allow for workers to take off from work due to family emergencies without losing all of their pay.
There are a number of other deductions from your pay that help fund retirement accounts, pay for medical insurance, or pay part of employer sponsored benefits. Some examples include:
- 401K Contributions – These contributions are typically tax-deductible and will reduce the amount of federal income tax being withheld from your paycheck.
- Medical Insurance – Depending on your employer, you may pay partial or substantially all of your medical premiums. Depending on the plan, these payments will be tax-deductible against your gross wages subject to Federal Income Tax.
- Life Insurance/Disability – Some employers provide supplemental plans that protect worker’s families in case of death or major disability. Employee’s will typically opt into these programs and have a small deduction from their pay every payroll period.
Have a Talk With Your Payroll Department
The best way to understand what is coming out of your specific paycheck is discussing with your payroll department. Depending on how you are paid (hourly/commission) your withholding amount could be vastly different. For example, commissions that are not part of your normal salary are subject to supplemental rates.
Your payroll department will be best suited to answer your specific questions and help you understand the difference between your gross pay and your take-home pay.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer. Photo Copyright: <a href='https://www.123rf.com/profile_bobaa22'>bobaa22 / 123RF Stock Photo