Federal and state tax withholding contributes to the difference between gross and net pay. Taxes include Social Security, Medicare, federal income tax and, for some people, state income tax. While you have no control over how much your employer deducts for payroll taxes, you have some control over income tax withholding. Although deductions may never be enjoyable, understanding what they include can make paying them less painful.
Social Security Tax
The Federal Insurance Contributions Act requires an employer to withhold a specific percentage of your gross pay to fund Social Security. The Social Security program funds retirement, survivors and disability benefits. As of the time of publication, the tax rate is 6.2 percent of your wages up to $117,000. Say your taxable gross pay, which is gross pay minus any pretax deductions for things like health insurance or a retirement program, is $2,000 per pay period; in that case, the deduction will be $124. Whether you make $117,000 or $200,000 annually, your Social Security deduction for the year will be $7,254
Medicare is a hospital insurance program that is also part of FICA. However, the Medicare deduction, unlike Social Security, has no annual wage limit. As of the time of publication, the tax rate is 1.45 percent of your taxable gross pay. For example, if your taxable gross pay is $2,000 per pay period, the deduction will be $30.80. Because all wages are subject to Medicare withholding, if your annual salary is $117,000, the total deduction will be $1,696.50, and if it's $200,000, withholding will total $2,900.
Federal Income Tax
Federal income tax withholding funds government programs, roads, jobs and other projects. Although the number of exemptions you claim on Form W-4 determines the percentage, withholding too little could cost you at year’s end. Not only could you face a large tax bill, but the Internal Revenue Service could also impose an underpayment penalty fee. The penalty is a variable rate interest payment that begins on the day the taxes were due and compounds daily until the IRS receives the money you owe. To help you get it right, the IRS has an online W-4 calculator. This interactive tool will walk you through a variety of scenarios and end by telling you what number to enter on your Form W-4.
State Income Tax
Some state governments also require an employer to withhold a percentage of taxable gross pay for state income taxes. For states that do, the process for determining how much your employer will deduct is the same as for federal income tax. In fact, some states use the federal W-4 form instead of a state-specific withholding form. Just as with federal income tax, the goal with claiming state income tax exemptions is to come as close as possible to your tax liability for the year. The more allowances, or exemptions from income tax withholding, claimed on a Form W-4, the less money is withheld for income taxes.
Based in Green Bay, Wisc., Jackie Lohrey has been writing professionally since 2009. In addition to writing web content and training manuals for small business clients and nonprofit organizations, including ERA Realtors and the Bay Area Humane Society, Lohrey also works as a finance data analyst for a global business outsourcing company.