Your Paycheck – Tying it all Together

This will be my last post in the Mini Series “Your Paycheck” it will be a large example incorporating all aspects of the previous posts in this series, Gross Income vs. Net Income, Taxable Income, Federal Allowances, Federal Income Tax Withholding, State Income Tax Withholding, Before Tax Deductions, and After Tax Deductions, Enjoy!

One quick note before I start: the goal of this post is to give you a template for calculating your own net income. You may have more or less of the pre-tax deductions, allowances, etc than stated in the example below. Following this methodology and substituting your information should yield correct results and give you a detailed understanding of how your paycheck goes from gross to net income.

Jackie is married and lives in the state of Illinois, her husband currently does not work; therefore his gross income is $0, for tax purposes they plan to file jointly. Jackie’s gross income is $65,000/year, she claims two federal allowances, makes an annual contribution of $2,600 (4%) to her 401(k), has a total benefits cost of $900/year (health, vision, dental, etc), and has no post tax deductions. What is Jackie’s take home pay?

Our 1st step is to determine Jackie’s taxable income

We first need to subtract her pre-tax deductions (401(k) contribution and benefits cost) from her gross income.

Total income after pre-tax deductions is $61,500, but the example also states she claims two federal allowances, in 2011 each federal allowance claimed lowers taxable income by $3,700. We must adjust taxable income for those two allowances as seen below.

Jackie’s total taxable income is $54,100 this is the number we will use to compute federal tax withholding, reference the federal tax withholding table below. We will also use $54,100 to calculate state income tax withholding.

Since Jackie is filing jointly we will use the second column of the above withholding table. See a breakout of the calculation below. (If you need more detail on how to use this table please reference the post on Federal Income Tax Withholding).

Total Federal Withholding is $6,080, but we can’t forget to compute social security and medicare tax as well, which if you remember are based upon gross income, not taxable income.

Now that taxes on the federal level have been computed we need to figure out state income tax withholding. Illinois has a flat state income tax rate of 5% so calculating withholding is pretty straight forward, taxable income x 5%.

Jackie has no post-tax deductions, so we are now ready to add all of the components above together and compute net income.

*Semi monthly values are simply the annual amount divided by 24.

There we have it! Jackie’s net income is roughly $49,000 per year. That is drastically different from her gross income of $65,000; $16,000 lower drastic! Granted she does keep the amount contributed to her 401(K)…but this large gap emphasizes the importance of knowing what happens to your money before it hits your pocket-book. Armed with this knowledge you can better pre-pare for taxes, retirement, health benefits, and monthly budgeting.

Here is a link to the tax calculator which will yield the same results as above using the sample data. Use it with your information as a double-check to your own calculations, or to take a quick look at your paycheck without having to perform all the calculations above. (Tip, “457 plan withholding” is where you input retirement plan withholding)

Hopefully you’ve enjoyed this mini series and you learned something new and informative.

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.