Your Paycheck – Before-Tax Deductions

Why this should interest you?

You could pay lower taxes!!

Before-tax deductions are subtractions from your gross income before taxes are computed, therefore lowering your taxable income. An example of a pre-tax deduction is a contribution to a 401(k) retirement plan or payment for benefits such as health insurance.

A simple illustration (assume no other tax except federal withholding, no social security medicare, state, local, etc)

Joe, a single male, is a video game tester and has a gross income of $2,000/month, this also happens to be his taxable income. In this instance Joe has $238.33* withheld from his pay check each month for federal taxes, leaving him with a net income of $1,761.67 ($2,000-238.33).

Next month, Joe’s boss announces the company will begin offering the option to contribute to a 401(k) retirement plan. Joe decides to take part and contribute $100 a month. His gross income is still $2,000/month but his taxable income has now decreased to $1,900 ($2,000 – $100). Contributing to the retirement plan lowers Joe’s federal tax withholding to $223.33* a month, a $15 reduction from the previous pay period. Joe’s net income is now $1,676.67. It is lower than last month, but remember, he keeps the $100 contributed to his 401(k), and when you add the contribution to net income, total income equals $1,776.67 which is $15 higher than last month.

As you can see pre-tax deductions are generally good, as they allow you to contribute or spend money before it is taxed, saving you money.

Other examples of pre-tax deductions

  • Retirement programs in addition to 401(k) such as a 403(b)
  • Employer benefits such as medical insurance, dental insurance, etc
  • Flexible spending accounts
  • Healthcare spending accounts

For more information specific to your pre-tax deductions contact your employers HR department.

*Federal tax withholding computed using the federal tax withholding table in the post Federal Tax Withholding. Remember to convert monthly gross income to an annual amount 1st.

Your Paycheck – State and Local Income Tax Withholding

State and local income tax withholding is the portion of income the state or local government withholds from your paycheck. Not every state or local government assesses an income tax so there is no general rule for how such a tax is administered. Some states such as Michigan have a flat state income tax (4.35%) while others use a graduated scale similar to the federal government. For states that use the graduated scale the logic used when calculating your state withholding is the same as calculating your federal withholding (reference: Federal Income Tax Withholding)

State income tax withholding is based upon your taxable income. The definition of taxable income on the state level can seem confusing because each state has its own regulations outlining what constitutes taxable income, and there is a chance it will differ from federal taxable income. In reality determining state taxable income is just as simple as calculating it on the federal level, take gross income and subtract any allowances or dedications permitted by the state, for example, some states allow any payments to a state college tuition fund to be deducted.

Since the laws regarding state income tax vary so widely across the US I will post general information below and some useful links for those who would like a more in depth look at a specific tax rates and information by state.

The lucky ones! States with no individual income tax (states in red tax interest and dividends)

  • Alaska
  • Florida
  • Nevada
  • New Hampshire
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

States with a flat individual income tax rate

  • Colorado – 4.63%
  • Illinois – 5%
  • Indiana – 3.4%
  • Massachusetts – 5.3%
  • Michigan – 4.35%
  • Pennsylvania – 3.07%
  • Utah – 5%

All other states not listed use a graduated scale, reference links below for details.

The top link this is a great compilation of every state’s individual income tax rates for the years 2000 – 2011, also the key at the bottom is helpful in determining if your state has any special circumstances. The bottom link is an interactive map, just click on your state to see income, property, estate, and other tax rates.

Unfortunately, I could not find a complete list of all local tax rates by state for 2011, but below is a link that shows local tax rates by state from 2008. The link can be useful to see if your city levies a local tax but, be cautious, there has probably been many changes made to the tax code since then. If you are interested in knowing if your local government assesses an income tax I would recommend checking your city or county website.

Some important notes:

Tax law can change frequently, the percentages shown here are for 2011 only (2008 for local), however, the logic behind the calculations tends to remain constant, a quick Google search should provide the latest tax rates.

Taxes withheld from your paycheck do not necessarily equate with taxes paid. If you usually get a refund this is because more tax was withheld during the year than what you owed and vice versa, if you owed money not enough tax was withheld.

I am not a tax accountant; this post is only meant to be a quick informative overview of state and local income taxes covering the basics. For detailed questions or concerns please consult a tax professional.

What is – A Federal Withholding Allowance?

A Federal withholding allowance is the governments way of allowing you to adjust your taxable income, the basis for the federal tax withholding seen on your paycheck. Allowances are claimed on IRS Form W4, (it is one of the forms you must fill out when starting a new job). Some examples of federal allowances are:

  • Dependents you claim on your tax return (ie children)
  • If no one else can claim you as a dependent on their tax return
  • If you plan to file as head of household on your tax return

In the tax year 2011 each federal allowance claimed reduces your taxable income by $3,700.


Mark is a single male with no children and has a gross income of $50,000/year; he has no pre-tax deductions, making his taxable income also $50,000/year. A few months later Mark gets a new job and needs to fill out his W4, he realizes he was claiming no allowances before, (being just out of college when he filled out his first W4 he didn’t quite know what he was doing) and adjusts to claim 1 (no one else can claim him as a dependent on their tax return). This lowers Mark’s taxable income by $3,700 to $46,300, which also reduces his monthly federal tax withholding, boosting his monthly net income or take home pay.

An important note

You can claim as many allowances as you want on your W4, but this does not change the amount of federal tax owed in a given year. Claiming an allowance only lowers federal income tax withholding, come tax return time if you claimed ten allowances but only two actually apply (the government will check, so will any tax prep software) you will be stuck with a big fat tax bill, owing big Sam all that money which wasn’t withheld from your paycheck. On the contrary, if you receive a large refund you may want to consider increasing the number of allowances claimed, instead of waiting an entire year for that money you will receive a small piece of it every month because of reduced tax withholding.    

What is – Taxable Income?

Taxable Income – The monetary base from which you are imposed a tax. Taxable income for the federal government is usually any income received over the course of the year (gross income) less deductions (such as a federal allowance or 401k contribution) and expenses as deemed allowable by the IRS. Taxable income at the state level is determined by the state’s taxing authority and can differ from the federal government and from state to state.

Simple example: John has a gross income of $50,000/year he contributes $5,000/year to his 401(k) retirement account and has claimed one federal allowance on his W4. In this case John’s taxable income would be $41,300.

Gross Income: $50,000

Less 401(k): $5,000

Less Allowance: $3,700

Taxable Income: $41,300 (this is the number you would use when referencing the IRS withholding tables to determine withholding)

Bottom line, taxable income is the number used to calculate the taxes you owe, whether it is to the federal, state, or local government.

Your Paycheck – Federal Income Tax Withholding

Why this topic should interest you?

This is your money and the government takes a piece before it even hits your pocket! Just because we must pay taxes by law doesn’t mean we should ignore them all together and hope for a refund when we file each year. Understanding the basic principles of federal tax withholding can prevent you from owing money to the government during tax season and could even boost your monthly net income.

Federal income tax withholding is the portion of income the federal government withholds from your paycheck. It is based upon taxable income, which is usually gross income adjusted for any tax deductions, like contributing to a retirement plan. There are three types of federal taxes withheld, the main federal withholding, social security, and medicare. All of them may or may not show up on your paycheck, depending on your status such as student, senior citizen etc.

Federal Withholding – This is the big boy, the main tax used to fund the federal government. It is based upon your taxable income and your filing status, single, married, etc. It is also a graduated scale, meaning the more you make the more you pay. Below is the 2011 IRS Tax Withholding Table.

Here is an example of how to use the table. Say you are a bachelor two years out of college with a gross income of $52,000/year and a taxable income of $47,000/year. Over the course of 2011 you should expect big Sam to withhold $7,350 in federal income tax. How did I arrive to this value? Remember, because of the graduated scale you can’t use just one tax rate, for our bachelor with a taxable income of $47,000/year we actually have to use the 1st three brackets of the first column (single filers) to calculate his total withholding. The first $2,100 of income is not taxed, the next $8,500 is taxed at 10%, the subsequent $26,000 at 15%, and the remaining $10,400 at 25%, this is done until the point where the next bracket can not be reached. The calculation for our example is shown below:

Federal MED/EE – This is Medicare tax, the current rate for 2011 is 1.45% of gross income, which your employer matches. With our above example our bachelor would have $754.00 ($52,000 x 1.45%) withheld and his employer would pay an additional $754.00. This is the same for everyone regardless of marital status.

Federal OASDI/EE – This is Social Security tax, the current individual rate is 4.2% of gross income, and your employer must pay an additional 6.2%. Using the example above the bachelor would have $2,184.00 ($52,000 x 4.2%) withheld and his employer would pay an additional $3,224. This is the same for everyone regardless of marital status.

A quick recap for our bachelor:

Over the course of 2011 a total of $10,288.00 will be withheld from his paycheck for federal taxes alone, that’s no small amount!

Some important notes:

Tax law can change frequently, the percentages shown here are for 2011 only, however the logic behind the calculations tends to remain consistent, a quick Google search should provide the latest tax rates.

Many other factors can influence the total amount of taxes withheld in a given year, such as any federal allowances and other types of deductions, etc. These items can reduce your taxable income and lower your withholding.

Taxes withheld from your paycheck do not necessarily equate with taxes paid. If you usually get a refund this is because more tax was withheld during the year than what you owed and vice versa, if you owed money not enough tax was withheld. You can change the amount withheld from your paycheck by modifying the number of allowances claimed on IRS form W4. To amend this form, contact your employer. For more information please see post on Federal Allowances.

I am not a tax accountant; this post is only meant to be a quick informative overview of federal income taxes covering the basics. For detailed questions or concerns please consult a tax professional.

For more information on federal income tax please reference

Link to a simple payroll withholding calculator

Your Paycheck – Gross Income vs. Net Income

Why this topic should interest you?

Many people know what their gross income is, but that is rarely the amount of money they take home. Knowing your salary, take home pay, and the reasons why the two differ can prove helpful in successfully managing your personal finances.

Gross Income

This is the number you knew when you had your first part-time job at insert name of first job here making $5.50 an hour, and the number you will know when you land that big full-time job with a $45,000/year salary. In other words it is what you make before any deductions, like taxes and benefits.

Net Income

When you start a new job and get the first paycheck this is the number that usually makes you go WTF?! I thought I was making more than that! It is your gross income less any deductions, like taxes and benefits. It is the final number you see on your paycheck or the number that is directly deposited into your bank account, it can be referred to as your take home pay.

It is important to note that this number can differ significantly from person to person even if their gross income is the same; this is due to differences in deductions.


These are items like federal and state taxes and are subtracted from your gross income.


Below is an example of a monthly paycheck, as you can see gross income is $1,875.00 but take home pay is only $1,445.07, this is because of the deductions that occur before the check even reaches your bank account (+ denotes income, – denotes deduction)

+ Monthly Salary (Gross Income)           + 1,875.00

+ Flex Benefits Credits                 + 188.24

– Federal Taxes                             – 308.60

– State and Local Taxes                – 0.00

– Before Tax Deductions               – 309.57

– After Tax Deductions                  – 0.00

= Net Income (Take Home Pay)             = 1,445.07

Now that you are familiar with the difference between gross and net income my next few posts will dig into the different types of deductions above and explain what they are and how they affect your paycheck.

Mini Series – Your Paycheck

I have decided to kick off my blog with a mini series focused on your paycheck. The paycheck after all, is how the money you earn enters your life, and it is beneficial to be familiar with how your salary is impacted before the cash you earn finally reaches your pocket.

Why this mini series should interest you?

Say for example last week you loaned your friend $100. Two weeks later he pays you back but only gives you $85. You would want to know why you only got $85 and where the remaining $15 went. This can be directly linked to your paycheck, but instead of loaning money you are giving your time in terms of hours worked. To make the link say you work 8 hours at $10 an hour, but at the end of the day get a check for $71, not quite what you expected, right? Were did the other $9 go? This mini series will help answer that question.

During this mini series I will be touching on various topics such as:

  • Gross Income
  • Net Income
  • Benefits
  • Federal Taxes
  • State Taxes
  • Before and After Tax Deductions

and possibly a few others, if you have a question or specific request related to your paycheck, leave a comment and I will do my best to answer in a future post.