W-2 Filing Status: Your Guide To Paycheck Deductions And Tax Withdrawals
If you're looking over your paycheck, you'll notice that the money you've earned and the money you've paid will be very different. There will be a list of paycheck deductions with various descriptions taking a big bite out of your hard earned pay.
Many workers have serious questions about them. What are they? Where do they come from? Do you have to pay them? Use this guide to figure out how much is deducted from your paycheck and where that money is going.
What are Paycheck Deductions?
A paycheck deduction includes anything that is pulled out of your paycheck before you receive it. Common types of deductions include tax withholding, health-related expenses, and retirement savings.
Withholding as a concept was introduced during WWII. The federal government, desperate for more funds, decided to automatically deduct income taxes through employers. It was such an effective way to perform taxation that it quickly caught on in other states and government entities.
Your employer's HR department calculates deductions for you and in many cases, you have no control over them. There are two broad categories of payroll deductions: involuntary and voluntary. Depending on your employer's payroll software you'll see different codes for different types of withholdings.
Involuntary deductions are mandated by the government. These are usually related to taxes or some form of court order. They include:
- Federal, state, and local tax withholding
- Social security, Medicare, and Medicaid
- Child support payments
There is no way to get out of paying these taxes.
If you've ever worked in the U.S., you're familiar with the IRS and their approach to tax collection. Depending on your income bracket, you will see different percentages of your pay taken via withholding.
This is based on information submitted in your W-4. This includes things like relationship status, children, disability, and a range of other possible exemptions. Depending on your previous year's tax return, you can file an exemption from withholding, and your employer will stop withholding federal taxes.
The current federal tax rates start at 10% and go as high as 37% for high-income earners.
All but seven U.S. states levy their own income taxes. They also use withholding to ensure full payment of taxes in a timely manner. The amount withheld will depend upon the state you live in and your income. You can find out what your state tax bracket is by checking out your state's department of revenue.
Different states have different exemptions available. Some allow you to file an exemption from withholding while others require you to withhold fully and apply for a refund during tax season. State income taxes are much lower than federal tax rates but can still add up.
Local income taxes aren't as common as state taxes but they do exist. Many large cities levy a small income tax on residents. Local taxes are rarely more than one or two percent of your income. In some cases, you can deduct local taxes from your federal tax.
Social Security, Medicare/Medicaid
Every U.S. worker is required to pay into both Social Security and Medicare under the Federal Insurance Contributions Act (FICA). The current Social Security tax rate for regular employees is 12.4%. Medicare takes an additional 2.9%.
You won't pay this amount all on your own. By law, employers are required to split this tax with you. Employees pay 6.9% for Social Security and 1.45% for Medicare.
Social Security taxes have a maximum assessment cap of $128,400. This is to prevent you from paying more into the system than you could ever hope to recoup. If you earn more than $200,000 you'll also see an additional .09% Medicare tax.
Court Ordered Child Support
If you have a court order requiring you to pay child support, you will see it withheld from your check every pay period. This doesn't apply to child support paid on an informal or non-court ordered fashion.
Child support will be withheld after taxes have been paid. Generally, it shows up as a base percentage deduction after state, federal, local, and Social Security deductions.
Voluntary deductions are those that you choose to have withheld from your paycheck. Common voluntary deductions include employer-sponsored insurance plans, health savings accounts (HSA), and retirement contributions.
Insurance and HSA
If you choose to purchase an insurance plan through your employer, the premiums will often show up as a pay deduction. If you sign up for an HSA this will also be deducted.
Employee-sponsored insurance plans include life insurance, dental, vision, and health insurance. The premium you agree to pay will be amortized over your annual pay periods and deducted from each. If you elect to create an HSA, you can contribute pre-tax earnings up to set limits as a payroll deduction.
There are several tax-advantaged retirement plans that allow you to contribute pre-tax funds. The most common are 401(K)s and 403(b)s. Once you reach eligibility within your company, you'll be asked if you would like to contribute. You can generally select any percentage to deduct up to legally prescribed maximums. Retirement contributions will be deducted from your pre-tax earnings and will show up on your pay statement.
The amount of money your employer pays you before tax is your gross pay. Net pay is the important number for most people. It shows you how much money you'll receive after all payroll deductions have been calculated.
You can try and figure out what your annual net pay is by adding up the various taxes and other pay deductions you participate in. Once you have this percentage you can figure out what you'll make over the course of a year.
Don't Be Discouraged by Withholding
Paycheck deductions can take a serious chunk out of your income. Perhaps this piece might be of interest to you, on medical deductions. It's a good idea to try and think of your actual pay as net pay. That way you don't come up short because you were calculating using your pre-withholding income.
Get started by creating your W-2 form today!