When I moved here a long time ago one of the financial mysteries for me was the taxes on my paycheck. This included what would be deducted from my pay check and more importantly how much should I withhold to meet my tax obligations. I learned the importance of understanding this the hard way with a hefty tax bill when I filed my return, due to not withholding enough taxes during the year.
Luckily I had sufficient funds to pay the tax liability and there was no fine as this was the first year I owed taxes. If I owed taxes in the subsequent year, there would have been a $300+ fine. With this in mind, I thought I would summarize my learning experiences around the taxes in ones paycheck and how they are calculated. I worked at large Fortune 100 corporation, which outsources it paycheck process to a national payroll company, so I imagine it contains most of the common elements present in paychecks.
Here are the key items and related tax details that you should be aware of:
1. The paycheck should have all your correct personnel details listed near the top – especially your location and tax marital status (married or single). If incorrect, you need to contact your HR or Payroll department to fix these as soon as possible because they will affect your tax obligations and amount you should withhold. Per the latest tax tables, tax rates and thresholds vary greatly by marital status.
2. The next section to look at is your Federal and State Exemptions (or Allowances). These are very important and suffice to say, could make the difference whether you pay taxes or get a refund at the end of the year. The exemptions you take will affect how much tax is withheld (deducted) from your paycheck to meet your annual expected tax liability. Generally the more exemptions you take the less tax is withheld during the year. The details behind this is separate post in itself, but the Internal Revenue Service (IRS) has detailed guide book and calculator (link below in references) to help you determine the appropriate number of allowances (or additional tax withholding) for your situation. It is long, but take the time to read it. When in doubt take zero exemptions.Talking to others I found that if you are renting or taking the standard deductions in your tax return, selecting no exemptions is the safest option. However this will vary for everyone based on their own individual situation.
3. The rest of your paycheck should contain your income details and various taxable and non-taxable deductions (like health insurance or 401K contributions you have elected to make). Remember your federal and state taxes are calculated on your Adjusted Gross Income. Next, look for a section that breaks down your withheld taxes and you should see the following four items :