With all the acronyms that appear on your pay stubs, it can be a challenge to keep track of where all your money goes. If you’re using a tax return calculator to estimate what you’ll owe or receive back in taxes at the end of the year, it’s important to know what amounts withheld from your paycheck count towards which taxes. Knowing what taxes you get back when you file your tax return helps you understand how much you’re actually paying in taxes.
You can receive a refund of federal and state income taxes withheld during the year if your actual tax liability is less than what was withheld. In addition, you can get even more back than you paid in if you qualify for refundable tax credits.
How to Get Tax Back
During the year, your employer withholds money from your paycheck to pay for income taxes. In addition, if you’re self-employed or have other income not subject to income tax withholding, you might make estimated tax payments. When you receive your paycheck, you’ll see that some of your earnings are held back for various taxes. These include not only federal income taxes, but also FICA taxes and, if applicable state and local income taxes.
At the end of the year when you file your tax return, you get to subtract your income tax withholding for each level of government tax from what you owe. Only include income tax withholding because FICA taxes are different than income taxes. So, when figuring how to estimate a tax refund, you can look at your pay stubs or your Form W-2 to find how much was withheld during the year.
If the result is a positive number, that means you didn’t have enough and have to pay the difference with your tax return. If the result is a negative number, you’ve had too much withheld and you’ll receive the excess back in the form of a tax refund. It is possible to owe money on your federal tax return, but receive a refund on your state tax return, or vice versa. Of course, to actually get a tax refund, you must file your income tax return.
For example, say you had $7,500 withheld from your paycheck for federal income tax withholding and $2,000 withheld for state income taxes. If your federal tax liability comes out to $8,000, you subtract $7,500 from $8,000 to get $500, which means you need to pay $500 with your return. If your state tax return shows a tax liability of $1,800, subtract $2,000 from $1,800 to get negative $200, meaning you will receive a $200 tax refund when you file your return.
Tax Deductions Versus Tax Credits
When you file your tax return, the tax code includes two broad categories of ways to lower your tax bill: tax deductions and tax credits. Tax deductions reduce your taxable income, which indirectly lowers your tax liability, while tax credits directly reduce your tax liability. You can calculate how much your tax credit will save you by multiplying the amount of your tax deduction by your marginal tax rate – the rate that you pay on your last dollar.
For example, say you’re in the 24 percent tax bracket and you owe $9,500 in income taxes. If you have a $1,000 tax deduction, multiply $1,000 by 24 percent to find that the deduction saves you $240 and will reduce your tax liability from $9,500 to $9,260. On the other hand, if you had a $1,000 tax credit, that drops your tax bill by $1,000 so that you only owe $8,500.
Because the value of a tax deduction depends on your tax bracket, the same deduction can save two different people very different amounts on their taxes. For example, say someone is in the 10 percent tax bracket and is eligible for a $2,000 deduction. That deduction only saves that taxpayer $200. However, if that same $2,000 deduction applied to a taxpayer in the top 37 percent tax bracket, that taxpayer would save $740 in taxes
Refundable Versus Nonrefundable Credits
Tax credits fall into two categories: refundable credits and nonrefundable credits. Both reduce your tax liability, but nonrefundable credits can only reduce your tax liability to zero for the year. If you have more nonrefundable tax credits than tax liabilities, the excess credits are wasted because they can’t reduce your tax liability below zero. For example, say your tax liability is $1,000 and you’re entitled to a $1,500 nonrefundable tax credit. The first $1,000 of the tax credit will wipe out your tax liability, but the last $500 will be wasted because you don’t have any additional tax liability to offset. Examples of nonrefundable credits include the saver’s credit, the adoption credit, the lifetime learning credit and a portion of the American opportunity credit.
Refundable credits, on the other hand, can reduce your tax liability below zero. If your tax liability drops below zero, you receive a tax refund for more than you paid in during the year. For example, say your tax liability is $2,000, but you have a $2,500 refundable income tax credit. Your tax liability goes to negative $500, meaning you’ll receive any income taxes withheld from your paycheck during the year back, plus another $500 on top. Refundable tax credits include a portion of the American opportunity credit, the earned income tax credit, and the excess Social Security and RRTA tax withheld credit.
You generally won’t receive a refund of any FICA taxes, sometimes called payroll taxes, withheld from your paychecks during the year unless there was an error. The FICA taxes include the Social Security tax and the Medicare tax, and these taxes are only applied to your earned income.
FICA taxes aren’t subject to the same deductions and credits as income taxes, so the withheld amount is almost always exactly what you owe. For example, say your salary is $62,000 but you contributed $5,000 to a traditional 401(k) plan and have a student loan that you paid $2,000 of interest on. Even though your taxable income after the deductions is only $55,000, you still owe the FICA taxes on the full $62,000 of earned income.
However, the Social Security tax only applies to a limited amount of earned income each year, called the contribution and benefit base. Any earned income in excess of the contribution and benefit base isn’t subject to the Social Security portion of the FICA taxes. Your employer will stop collecting the Social Security portion of the payroll taxes when you cross that threshold. However, if you work more than one job, your employers won’t know how much you’ve earned elsewhere. In that case, you’ll receive a refund of any excess Social Security withheld when you file your tax return at the end of the year.
For example, the 2018 contribution and benefit base is set at $128,400. If you earn $116,000 at one job and $29,000 at a second job, your total income for the year of $145,000 is well over the contribution and benefit base of $128,400. However, because your earned income at each job is less than the contribution and benefit base, each employer will withhold the Social Security taxes on all of your earnings. As a result, you’ll have $1,029.20 extra withheld. But, when you file your income taxes, you can claim a tax credit equal to $1,029.20 so you’ll get that extra back.
Additional Medicare Tax
For high earners, the tax code levies an additional Medicare tax of 0.9 percent on certain earned income. However, this tax only applies to earned income after you exceed the threshold for your filing status. For singles and heads of household, the threshold is $200,000 of earned income. If you’re married, the threshold is $250,000 if you file jointly, but only $125,000 if you file separately. Despite the different thresholds for when the tax actually applies, all employers are required to start withholding the additional Medicare tax from your paycheck after they have paid you $200,000 during the year. As a result, it’s possible that you could have money withheld for the additional Medicare tax from your paycheck when you won’t owe it at all.
For example, say that you’re married and will file a joint tax return with your spouse. You are the only spouse who earns an income, and you earn a salary of $225,000 for the year. Your employer will withhold the additional Medicare tax on your last $25,000 of income, for a total of $225. But, because you’re married filing jointly, you won’t actually owe the additional Medicare tax at all because your combined earned income is below your threshold of $250,000. Therefore, you’ll receive a tax refund of the $225 your employer withheld.
There are also some taxes that you won’t get back directly, but you could use them to increase the size of your tax refund. Each year, you have the option to deduct either your state and local income taxes or your state and local sales taxes. While most people pay more in state and local income taxes, if you made very large purchases or live in a state without an income tax, you might benefit more from deducting your state and local sales tax. You can also deduct foreign income taxes on your return.
In addition, you can also write off property taxes and real estate taxes. To count as a real estate tax, it must be levied against all property in the jurisdiction at the same rate. Real estate taxes don’t include charges for improvements to property, like sidewalks or sewers. If you have a mortgage, you may pay your real estate taxes through an escrow account. If so, you need to deduct only the amount that was paid out of the escrow account during the year for real estate taxes, not amount you paid in. Personal property taxes include taxes based on the value of the asset, such as a car or boat, that are calculated annually, even if you pay it more or less often.
However, all state and local tax deductions are capped at a total of $10,000 (or $5,000 if you’re married filing separately) The cap doesn’t apply to any foreign income or real estate taxes. So, if you have $8,700 of state income taxes to deduct, you’re limited to deducting just $1,300 of state property and real estate taxes. But, if you have a vacation property overseas, you can still deduct all those real estate taxes.
In addition, to claim a deduction for any of these taxes, you must itemize your deductions. So, if your standard deduction exceeds the value of all of your itemized deductions combined, these taxes won’t actually save you anything on your taxes. For 2018, the standard deductions are $12,000 for singles and married people who file separate returns, $18,000 for heads of household and $24,000 for married couples filing a joint return.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."