Paycheck Taxes

[jeffrey]

By Teri Newton

So you made it out into the real world and received your first paycheck. Wait a minute...Where did it all go? You were expecting X amount of dollars, but probably received a lot less.

It amazes me how little the average person really understands about the money that comes out of their paycheck for taxes. You probably appreciate far less how much in taxes your employer pays on your behalf. Most of this was a pretty big mystery to me until I went to work for a small CPA firm and started preparing payroll tax returns. I probably now know more than I ever wanted to about the subject, but I sometimes wonder why this is not required as part of our basic education before entering the workforce. You shouldn’t have to be an accountant to understand your paycheck.




Most of us probably have Social Security, Medicare, federal withholding, state withholdings, and other state/local taxes withheld from our checks every payday. Granted, some government employees receive some reprieve and/or pay some alternative taxes, but this discussion is for the average American corporate employee. Keep in mind there are many exceptions to the rule, and if you are reading this article and scratching your head, this is probably why.

For 2007, the first $97,500 you earn will be taxed at a rate of 6.2% for Social Security. It doesn’t matter if you are so young that you will most likely never see that money again. If that upsets you, your only recourse is to write your Congressman. On the other hand, the good news is once you pass the threshold for the year, the tax will no longer be withheld from your check. Until next year anyway.

The Social Security rate of 6.2% has held steady for quite some time, but the threshold tends to increase every year. Social Security taxes are paid on an individual level; there is no discount for being married. If you and your spouse both make $90,000, then your wages will both be fully taxed by Social Security. Social Security withholdings are sometimes referred to as OASDI (Old age, survivors, and disability insurance) or FICA-SS (Federal Insurance Contributions Act - Social Security).

Next comes Medicare. 1.45% of every penny you earn is paid in to Medicare. There is no threshold. Whether you make $5 or $500,000, the entire amount will be taxed for Medicare at a 1.45% rate. This tax rate has been sitting steady for many years as well. Interestingly, when you receive Social Security income in retirement, a small amount is withheld from that money for Medicare premiums. Not only is this something that never really goes away, but the government is starting to significantly raise the premiums of well-off retirees. The law seems to change with the wind these days so I wouldn’t get too excited about this part yet unless you are already in retirement. Medicare may show up on your paycheck as FICA-MC.

The 401k deferrals and medical premiums deducted from your paycheck may not be subject to income tax, but they are still subject to Social Security and Medicare taxes, which means you still pay the respective 6.25% & 1.45% taxes on these amounts. If you participate in a cafeteria-style benefit plan, however, the premiums may not be subject to Social Security and Medicare. This makes cafeteria plans a better tax deal than standard health insurance. Of course, 401k deferrals and health insurance premiums often come out of your check, in addition to taxes. These are just some examples of other items that will decrease your bottom line.

Then there's the biggest tax deducted from your paycheck: federal withholding. An abbreviation you may see on your paycheck for withholding is "w/h." This is the amount of Federal income tax you have withheld from your paycheck on a regular basis. You can adjust your withholdings with a Form W-4 to withhold less or more, but it is best to withhold the amount you expect you will owe for the year.

The good news in all this is that you are not funding social security by yourself. Your employer matches your Social Security and Medicare contributions. Your employer actually submits payroll taxes within a week, or month, of every paycheck issued. However, your employer has until the end of the year to prepare your W-2. This is how they report to the government how much you were paid, and how much tax was withheld from your checks for the year. Your employer needs to prepare your W-2 by the January 31st deadline, and the IRS uses this info to compare against the income and tax withholdings you report on your income tax return.

If you are self-employed, then you have the joy of matching your own Social Security and Medicare taxes, and paying the "employer match" yourself. This is the hefty self-employment tax that you pay in addition to income taxes.

In addition to matching your Social Security and Medicare (switching back to the non-self-employed) your employer also pays Federal Unemployment Taxes and State Unemployment taxes. These amounts are based on small percentages of your paycheck.

This leads me to the state taxes withheld from your paycheck. In California you will have State Disability Insurance (SDI) withheld from your paycheck. In New York City you will actually have city taxes withheld from your check. Every state and locality is different of course. In many states you will also have state withholding for state income taxes, similar to federal withholding. However, if you live in a no-income-tax state, then you luck out (well, at least when it comes to your paycheck). For those of you who pay in-state income taxes, you’ll know if you still owe or are due a refund instead, when you file your state income tax return. Employers remit these taxes on a quarterly and/or annual basis, depending on the state.

Sometimes if you work for multiple employers, too much Social Security or state/local tax is withheld from your various paychecks. In general you are allowed a refund of these amounts on your income tax forms. There is a space on the forms to claim these amounts under the line item for taxes withheld. If you don’t catch an instance of over-withholding, hopefully your tax preparer or tax software will. Of course, if you ever notice a payroll tax error during a tax year, you can request your employer to fix it before year-end. If the error is due to the fact that you have more than one employer though, you generally have to wait to file your tax return to get your money back.

It's important to know what all these items are and what portion of them is your responsibility so that you can catch any mistakes that occur and you can apply for any refunds that you may have due. If you see money is being withheld from your paycheck and you can't understand why, it's worthwhile visiting your personnel office to get an explanation. By becoming better informed about how money is taken out of your paychecks, you'll be in a better position to take control of your finances.

[LuxLiving]

Thanks for the percentage figures - very helpful (I guess I mean, duhhhhhhhh, I could've figured this out for myself at anytime but didn't! so thanks for having done the obvious for us.)

[jIM_Ohio]

I like the article info. I do think the editorials on policitians should be limited.

SS cannot "go away". If it did, I think 50% of retirees would be out on street.

It will be reformed (through increased taxes, decreased benefits, or something in between).

It would also help if during a discussion like this, the other side- what you get for your taxes/SS/medicare is also mentioned.

The post briefly mentioned SS as disability insurance, and this to me was important. Don't overlook the fact that once you get 40 SS credits, you get a full SS benefit (according to SS statements I get in the mail).

[Aleta]

What does that mean a full social security benefit? My husband just received his and it shows 40 years paid, but he didn't receive any kind of letter like that. What would determine how much he would be paid?

[jIM_Ohio]

I believe you get 1 credit per quarter worked (so your husband has 160 credits if he contributed SS for each quarter of the 40 years).

To collect "full benefit", I believe you need 40 credits. I am 34 yo... this does not mean I can collect now, but if I become disabled, I have enough credits for my full benefit...

[MonkeyMama]

Jim - Awww, you assume much about my political leanings. I didn't editorialize at all, was really writing to my audience who often complains about social security. I guess I didn't realize the fact that social security was broke and no one was fixing "right now", didn't realize that was up for debate. But I just had to clarify I do not think SS is going away or should go away. Mostly I Don't think it can go away. But I have been hanging around the boards seeing too many people complain. Yeah a lot comes out of our checks that we never expect to see (The very young) but it is an extremely complex issue... I just had to clarify my stance. Plus my pet peeve is when people whine. I am one for action. SO I had to throw it in there - if you are not happy - stop whining - Do something about it... This doesn't mean that is my political stance. I just had to clarify lest anyone assume I am anti-social security and I want it gone. Yikes!!! All the more reason to keep the politics out I guess.

On the plus side, I think you bring up a good point Jim for another article - good idea. I have been feeling out our demographics of these sites and it is getting more obvious to me there would be interest in an article on social security benefits. I think it would be well received.

Aleta - do you receive social security statements? They generally tell you what you need to know about your benefits. You will usually get one statement every year for every person in your household who has earned benefits.

[tinapbeana]

Originally Posted by MonkeyMama

Aleta - do you receive social security statements? They generally tell you what you need to know about your benefits. You will usually get one statement every year for every person in your household who has earned benefits.

i've always heard this, but as someone who has worked for the past 10years i received my first statement at the end of '06. perhaps they were mailed and never got to me, but my moving and mail forwarding habits were the same in '06 as they were any other year...

[MonkeyMama]

Hmmm, I am trying to remember when I got my first statement - it was probably a few years after I started working. But I am not sure. You might need to work a few years to build up enough credits??? I really don't know. Something to research for a future article!

[Aleta]

MonkeyMam: Yes, we do get the statements and it shows the benefits. It sounded like full benefits meant maybe more money. I understood that you needed 10 years or 40 quarters to be able to claim social security and I know that they look at your best 20 or 30 years to determine your benefit.

[tinapbeana]

Originally Posted by MonkeyMama

Hmmm, I am trying to remember when I got my first statement - it was probably a few years after I started working. But I am not sure. You might need to work a few years to build up enough credits??? I really don't know. Something to research for a future article!

hence my confusion: my statement said i already have 36 credits and i just turned 29 this week! who knew i'd worked so much w/o ever getting a statement? i mean, i FEEL like i worked all the time but now the SS administration is actually backing me up

[jIM_Ohio]

Originally Posted by MonkeyMama

Jim - Awww, you assume much about my political leanings. I didn't editorialize at all, was really writing to my audience who often complains about social security.

As a technical writer, maybe it was style...keeping in mind my writing leaves LOTS to be desired (I was hired because I'm technical, I'm far from a good writer) but here's a couple examples

It amazes me how little the average person really understands about the money that comes out of their paycheck for taxes.

I sometimes wonder why this is not required as part of our basic education before entering the workforce.

It doesn’t matter if you are so young that you will most likely never see that money again. If that upsets you, your only recourse is to write your Congressman.

The third one I took offense to. The second editorial I actually agree with.

I notice on the articles section of this site in particular I see bad information. This was a good post (outside of some editorials which I took offense to).

I did not know the percentages I paid into the system, and I did not know SS wages are capped, or what cap was. This was a good subject to post on.

[jIM_Ohio]

Originally Posted by Aleta

MonkeyMam: Yes, we do get the statements and it shows the benefits. It sounded like full benefits meant maybe more money. I understood that you needed 10 years or 40 quarters to be able to claim social security and I know that they look at your best 20 or 30 years to determine your benefit.

I am unsure of what a credit really means, other than you are entitled to the full benefits you've worked to earn.

SS web site link

Find An Answer to Your Question


link to "credits" explanation



Answer

quote from article

Question
I worked for the last 10 years and I now have my 40 credits. Does this mean that I get the maximum Social Security retirement benefit?

Answer
Probably not. The 40 credits are the minimum number you need to qualify for a benefit. The amount of the benefit, however, is not based on those credits; it's based on your earnings. We determine your average earnings over your working years and use a special calculation formula that is set by law. For most people like you who need 40 credits, we must average their best 35 years of earnings to figure the benefit amount

The actual answer is you don't get a minimum benefit until you get 40 credits.

some good reading...

Social Security Statement: How Your Benefit Is Figured

Here's how we figure your Social Security benefit at full retirement age if you turn 62 in 2007:

Step 1- We determine the number of years of earnings to use as a base. If you were born after 1928, that base number is your 35 highest years of earnings. Fewer years are used for people born in 1928 or earlier.

Step 2- We adjust the earnings in these years for wage inflation. We call this "indexing."

Step 3- We determine your average adjusted monthly earnings based on the number of years in step 1. (If you don't have earnings in 35 different years, some years with $0 earnings will be used to figure this average amount.)

Step 4- We multiply your average adjusted monthly earnings by percentages in a formula that is set out by law. If you turn 62 in 2007, that formula adds together:

90 percent of your first $680 of average monthly earnings,

32 percent of the amount between $680 and $4,100, and

15 percent of everything over $4,100 to give you your full retirement benefit amount. (If you start your benefits before you reach full retirement age, this amount will be reduced.)

So the best benefit is for those which worked 35 years (to minimize "0" benefit years).

Once I wrap myself around this, I smell a blog entry. LOL

[krayziebone33]

This is definitely a good read. I knew all the figures before reading this, but I will still pay a lot more attention to my taxed dollars and where they are going.

[paycheck2paycheck]

I have always paid in too much and always get a refund which I have always looked forward to but doing the math I see that I could take home just over $400 a month!I understand to do that I have to redo my W4...something about increasing my allowances(dependents?)While I want to increase my take home I don't wish to face next year owing taxes..Can anyone explain how this works?

[kork13]

Originally Posted by paycheck2paycheck

I have always paid in too much and always get a refund which I have always looked forward to but doing the math I see that I could take home just over $400 a month!I understand to do that I have to redo my W4...something about increasing my allowances(dependents?)While I want to increase my take home I don't wish to face next year owing taxes..Can anyone explain how this works?

It's actually pretty simple. Print out a copy of the Form W4, then follow the directions in filling it out. If you're single, you are probably taking 0, 1, or 2 exemptions currently--You can find out exactly how many on your most recent pay stub. In line 5, just enter 1 or 2 exemptions above your current level.

Once you have everything filled out, just bring the lower half of the form to your employer's payroll office and they'll process it for you.

[DavidWarner]

Tax is something I was never comfortable with. This is a good read though. Thanks.

[backtaxpro]

It amazes me as a professional why the IRS makes the code complex. Yes I probably wouldn't have a job, but some much money would be saved that other jobs would be available.

[LoanAmortization]

It looks like starting in 2013, the US will consolidate the bottom 2 tax brackets. According to wiki it will be 15%.

[LoanAmortization]

It looks like starting in 2013, the US will consolidate the bottom 2 tax brackets. According to wiki it will be 15%. The 0% break for capital gains will also become taxable.