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

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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.

Deductions

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

Example

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.