When you get one of your first paychecks, you might notice that the amount is lower than expected. That is not an error; the difference is due to taxes. But what percentage of your paycheck goes to taxes?
And how exactly can you calculate the paycheck withholding from your total income?
Figuring out what your take home pay is going to be can get a bit tricky. There are a couple of tax withholdings you should know about, and you’re all set.
Let’s get into it!
Your Paycheck Is Here
Let’s start with your paycheck, shall we?
A paycheck is a document that demonstrates to a financial institution, such as a bank, that you are being paid for your work and that the institution is obligated to transfer the money to you.
There are several types of paychecks, each distinguished by the frequency with which an employee is paid. Some people receive their paycheck once per month, while others receive it twice per month, and some get to receive it once every two weeks.
In the past, people would receive their paychecks in person or through the mail. However, almost everyone in today’s society just gets a direct deposit into their bank account.
On the other hand, tax deductions are something everyone shares in common.
You’ll see some of the critical information when you get your paycheck.
- Check number
- Employer’s name and address
- Employee’s name and address
- Check date
- Payment amount
- Employer’s bank account and routing numbers
- Check memo (which is optional)
What Is a Pay Stub?
There is a difference between a paycheck and a pay stub.
Paycheck stubs can’t be cashed in for cash, but they contain crucial information about your finances.
The following is an example of what you might find on a pay stub, but remember that the information may vary depending on the state where you work:
- Pay period
- Hours
- Gross pay
- Take-home pay
- Federal income taxes
- State and local taxes
- Medicare and Social Security taxes
- Deductions and Benefits
- Year-to-date pay
- PTO balances
What Is the Federal Income Tax?
Your employer will deduct a certain amount from each paycheck you receive to pay your share of the federal income tax withholding.
You are subject to federal tax withholding, regardless of which state you work or live in, as is every other worker in the United States. Federal taxes are collected from all employees.
However, the exact amount you need to pay for your taxable income does depend on different factors, like your gross income, filing status, and other circumstances.
However, how does your employer determine the amount of money that should be set aside in your name? And how do they take it out of your taxable income? Form W-4 is entirely responsible for this outcome.
How Your Federal Income Taxes Are Calculated
When you start working for your employer, you must complete Form W-4.
The W-4 form stores information about you, such as how much money you make, whether or not you are married, and other personal details. All of this information will play a role in determining how much tax you owe.
This is why updating your Form W-4 with every significant change in your life is essential. For example, if you get married and want to file jointly, you have to state that on this form. Also, if you have children, you must list them on the form as dependents.
Even the Form W-4 went through some changes recently, like no more withholding allowances and the ability to indicate additional income. So if you haven’t checked your Form W-4 in a while and you have other income or some other big life change, this might be the perfect time to update it.
Please do not put this off any longer than necessary because it may significantly affect how you are taxed! If the IRS finds out your federal income tax withholding isn’t as big as it’s supposed to be, you’ll face penalties.
Regarding the Internal Revenue Service (IRS), you should be aware of this. You could adjust your tax withholding, but you might owe money if you’re not careful. And if you cannot pay the money owed to the IRS, you will be subject to severe legal consequences. No worries, you can find tax software online that can help with calculating this.
There are also ways to lower your tax bill by using stuff like tax credits, contributions to charity, earning income from stocks, etc. A lot of times, tax credits involve ecology as well.
On the other hand, if you don’t adjust your withholdings and keep them as they are, you’ll have a big chance for a tax refund! This means that the federal government owes you money, which is pretty cool.
Every piece of information requested on these forms is connected to the tax bracket you fall into.
2023 Tax Brackets
The American tax system is progressive. This means that if your taxable income falls into a higher tax bracket, the higher the marginal tax rate you need to pay.
The IRS determines the federal tax brackets, which differ depending on your filing status. There are different brackets for single filers, those married filing jointly, married filing separately, qualifying widows, and heads of households.
Also, these tax brackets tend to change with every tax year due to inflation and other factors.
Here’s what the tax rates look like for those that pay income tax for the 2022 pay period, sorted by their filing status.
| Single filing | Married (jointly) or as a Qualifying Widow | Married (separately) | Head of household | |
| 10% | <$10,275 | <$20,550 | <$10,275 | <$14,650 |
| 12% | <$41,775 | <$83,550 | <$41,775 | <$55,900 |
| 22% | <$89,075 | <$178,150 | <$89,075 | <$89,050 |
| 24% | <$170,050 | <$340,100 | <$170,050 | <$170,050 |
| 32% | <$215,950 | <$431,901 | <$215,950 | <$215,950 |
| 35% | <$539,900 | <$647,850 | <$323,925 | <$539,900 |
| 37% | No limit | No limit | No limit | No limit |
How Do Tax Brackets Work?
One thing that should be considered is that, in a progressive tax system, tax brackets are calculated at a marginal rate.
Here’s what that means.
Let’s say your annual salary is $200,000 and your filing status is that of a single taxpayer. Since you fall into the tax bracket of over $170,050, your tax rate is 32%.
But that is not the tax rate for your entire taxable income. That’s only the tax rate for the amount you make over $170,050. So, in the end, your tax rate looks like this:
- 10% for taxable income up to $10,275; plus
- 12% for taxable income between $10,275 and $41,775; plus
- 22% for taxable income between $41,775 and $89,075; plus
- 24% for taxable income between $89,075 and $170,050; plus
- 32% on the amount over $170,050.
You’ll notice that even when you’re in the 32% marginal tax bracket, the taxes withheld will be about 22% of your gross pay. So, the higher tax bracket does mean a higher bill, but not as much as that scary number!
And if you’re in the lower tax bracket of up to $10,275, you won’t have to pay the marginal tax rate, but you’ll have a flat tax rate of 10%.
But federal income tax isn’t the only deduction you’ll face. You’ll likely also have to pay for the Federal Insurance Contribution Act, or FICA for short.
What Is FICA?
In contrast to the federal income tax, FICA contributions are split between the employee and the company that employs them. This indicates that they contribute an amount equal to what you take from your paycheck.
There are two FICA contributions you need to know about. Social Security and Medicare. You pay for both today, so you can use them when you’re older.
Also, you can’t avoid FICA contributions. There are only some instances where people don’t have to pay these taxes, like in the case of certain religious sects, foreign government employees, non-American citizens working in the United States, and students that work for the schools they study at.
And if you don’t fit into any of these categories, you will have to shell out some cash when the tax bill comes!
Here’s what you should know about Social Security and Medicare taxes.
Social Security Taxes
With every paycheck, 6.2% of your income is deposited toward Social Security. In addition, your employer will match the amount.
However, there’s also a Social Security tax cap, and it’s $160,200 for 2023. This means all the income over that amount won’t have taxes withheld.
Medicare
Next up is the Medicare tax, which works similarly to Social Security. However, there’s no taxable income limit for these taxes.
You can use the Medicare programs when you’re a senior to cover medical expenses. When you get your paycheck, 1.45% will be withheld for Medicare taxes. And also, your employer will match this amount.
However, if you make over $200,000 annually, you’ll have to pay an additional 0.9% for Medicare taxes. But you only contribute that extra amount since your employer won’t match you.
State and Local Taxes
The federal income tax and FICA withholdings are the most significant part of paying your taxes, and they apply to the entirety of the U.S.
However, most states have their state taxes on top of it, and some areas even have their local taxes. These don’t depend on your tax bracket. Here’s what you should know about that.
State Tax
The state tax rate dramatically depends on where you live. Eight states in the U.S. don’t have a state income tax, but others do, and they can differ.
Like the federal income tax, state income taxes are calculated thanks to Form W-4. Your employer will know how much money they must withhold for these tax purposes.
It can get tricky, though. For example, if you work in one state and live in another, you must pay the state tax for both.
Local Tax
Some areas also have local income taxes, but not all do. Thai is more prevalent in bigger cities, although there are exceptions.
Tax rates depend on local governments, but the process is all the same. You supply the employer with the Form W-4, and they withhold the right amount of taxes for you.
Other Deductions
Besides just these taxes, you might notice some other itemized withholdings and additional taxes on your pay stub. For example, there could be deductions if you have health insurance or life insurance.
You could also have withholdings if you set money aside in retirement accounts like a 401(k) or Roth IRA.
It’s essential to make a distinction between before-tax and after-tax deductions here. If there are any before-tax deductions, you’ll have a lower income, which could also mean a lower income tax. However, you’ll have to pay for these pre-tax contributions in the future.
And if there are any post-tax reductions, the taxes are already paid, so you don’t have to worry about getting audited.
And finally, there are plenty of other possible deductions that could lower your take-home pay, and it all depends on your job, income level, and current life situation.
Income You Won’t Have to Pay Tax For
Most Americans feel the sting every time they have to pay taxes, but they also feel relief when they get that tax refund.
We want to save more, we want to use that money for something else, and we want to be financially free. But saving enough money for the future seems impossible when you have to use after-tax dollars or pay taxes on those tax-deferred accounts.
But does it have to be that way?
Isn’t there a financial process you can use to build wealth with already taxed income so you have a chance to take home more?
Say hello to Lifestyle Banking.
How Does Lifestyle Banking Work?
You only need two things to make Lifestyle Banking work for you.
One is an overfunded whole life insurance policy, and another is a lot of discipline.
Here’s a quick rundown of how it works:
- You overfund your whole life insurance policy and build cash value with after-tax dollars
- The money in the account grows at a guaranteed rate
- You take out a loan from yourself and use it for your financial plans
- You pay yourself back with interest and watch the funds compound.
And all the money you’ll get from the compound interest won’t be taxed once you take it out of the account because you put in after-tax dollars!
Doesn’t that sound amazing?
Of course, you need a strong mindset and extraordinary discipline to make this financial process work for you. It’s more than just playing with money. You have to be intentional.
Are you ready to find out more about Lifestyle Banking?
From Gross to Net Pay: Is Your Money Really Yours?
Nobody enjoys tax season, but we must file taxes either way. In any case, we hope this article helped you learn more about what your paycheck entails and what portion of it goes to taxes.