Taxes and my Paycheck Withholdings

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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 :

– Fed Withholding – This is the amount of federal taxes you are having withheld. America has a PAYG (pay as you go) progressive taxation system where taxes are set aside or withheld from your paycheck during the year rather than having one massive tax bill at the end of the year. Think of this as the taxes you are paying in advance. You can choose to have less tax withheld in each paycheck by increasing the number of exemptions/allowances you select in step 2. Alternatively you can choose to have more tax withheld if you feel that the standard withholding is not sufficient.

For example, on a $50,000 adjusted gross income your tax federal tax would be about $16,981 (25% single tax bracket) that works out to $653 per biweekly pay period. If this amount is not being withheld from your paycheck you could be liable for taxes at the end of the year.

– Fed MED/EE – is the Federal Medicare tax. This should be 1.45% of your gross salary.

– Fed OASDI/D – Federal Old Age Survivors Disability tax, which is also known as the Social Security tax. The idea is that this will be paid back to you as a pension when you retire. It is debatable whether this will be the case given government spending, but that is the subject of another post. The Social security tax rate for wages paid is 6.2% of gross salary (up to the annual limit). Your employer contributes a matching amount on your behalf.
– [State] Withholding – As with your federal withholding you withhold taxes for your state income tax liability. Each state has a different tax rate so withholding amounts will be different by location. Click here for a listing of state income tax rates.Hopefully this article should help you get started on understanding your paycheck and taxes in it a little bit better. It is also a good guide to review your current paycheck. Take the time to ensure that the correct taxes are being withheld so that you don’t have a large tax bill at the end of year. On the flip side, you also don’t want too withhold too much and have a big refund in the subsequent year. This is because you are giving up money you rightfully should have and could have invested, as opposed to a free annual loan to the federal and state tax departments. Using last years returns and references in this article should help you determine the right of amount of taxes to withhold. If you have any feedback on the above or additional tips, do leave a comment.

Supplementary information

Your paycheck will probably contain a lot of other information not mentioned here. So here are three good samples I found online with descriptions for all sections normally in a paycheck. Click the following links to view them: Example 1 and Example 2 and Example 3


Definitions in your paycheck to know from a taxation perspective:

Gross Salary is the amount your employer pays you before any deductions, i.e., John gets paid $50/hour as an electrical engineer. His annual gross salary is $50/hour x 2,000 hours/year = $100,000/year.

W-2 Wages = Gross Salary less (contributions to employer retirement plan) less (contributions to employer health plan) less (contributions to some other employer plans)

Adjusted Gross Income (AGI) is Total Income (Gross Salary, bonuses and other income) less some specific allowed deductions (such as; alimony, home or student loan interest etc)

Resources:
IRS witholding calculator

Related Posts:

~ Filing your taxes: D-I-Y Taxation Software or a Professional Preparer
~ Capital Gains and Losses : Tax Facts and Figures

{ 2 comments… read them below or add one }

jasmyn November 7

there are not any federal withholdings on my check yet my employer is paying federal taxes on my behalf. Help me and tell me what exactly do I need to change and will this make me receive less on my tax return?

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Andy (Author) November 7

FICA taxes are shared by the employer and employee. Not sure what you mean that the employer is paying your taxes. To adjust your withholding see the steps in the above article. Also I suggest talking to your HR/Payroll administrator.

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