Week 5- I earned $400 so why don’t I bring home $400?

Dec 14, 2020 Paycheck deductions, FICA taxes, Accountant, Tax Help, Benson, Dunn, Four Oaks, North Carolina

Look at how much they took out of my check……from our first paychecks at a part time job we had in high school till current time, we look at our pay stubs and think what it would be like to get “all the money we earned '' this past pay period. By why do they hold taxes from our checks?

Social Security and Medicare Taxes

Back in 1935 at the height of the depression, President Roosevelt proposed the “New Deal.” You probably learned about this in US History class. If you have forgotten, it was a large number of government programs and regulations created to hopefully prevent the Depression from happening again. Part of the New Deal was enacting Social Security.

This was a national backup plan so retired people would have at least a small amount of income if their job didn’t provide for their retirement (or lost the money in a financial crisis like the depression). Starting in 1937, employers were authorized to withhold a small portion of every worker’s wages and submit it to the Social Security Administration. At the time, it was 1%. Over the years, Social Security has expanded to offering benefits to spouses, dependents, and disabled people.

In 1965, Medicare was signed into law by President Johnson providing for universal healthcare for people over 65. In 1966, contributions started being collected from paychecks.

These are both a flat tax. There are no deductions, no forms, no refunds. You do not get a dollar-for-dollar value for them. If you die before retirement age, you get nothing. Everyone pays into the fund and those in need receive the benefits.

At this time, and since 1990, the social security deducted from your check is 6.2% and the Medicare rate is 1.45%. Together that is 7.65% ($7.65 of every $100) that your employer takes from your check. The IRS enforces the collection and sends the money over to Social Security.

Federal Income Tax Withholding

In 1916, during World War I, the federal government had bills from the war and needed money. The 16th amendment was passed by Congress and the Federal government began collecting tax on peoples’ incomes. Prior to that, income tax was not legal.

From its inception through the first 20 years or so, people figured out how much tax they owed and mailed in a check. In 1939, less than 6% of the American people owed any income tax at all.  Then World War II happened, and the feds needed money. Tax rates exploded.

In 1943, Federal Income Tax went the way of Social Security and the government decided to take money from everyone’s paycheck rather than wait until they sent their tax payments. Income tax withholding started. By 1945, 74% of Americans owed income tax. That went from almost no one to almost everyone in six short years.

Note that this is ‘withholding’ and not ‘tax’. That means you are paying on a future tax bill you haven’t gotten yet. You will get a dollar-for-dollar credit on your tax bill for what you pay during the year. If you pay in too much, you get a refund. If you don’t pay in enough, you pay the balance.  Withholding means you are paying your bill in advance.

How Much Gets Taken Out?

But how does the government know how much to take from your check? One person earning $10 per hour may have 2 kids to support and not pay any taxes while someone else in the identical job may have another job paying $30 per hour and pay a lot in taxes.

This is figured on form W-4. The employee tells the employer how much to withhold. Everyone fills out this form when they are hired. I’ve heard some pretty crazy advice (other than reading the instructions…) from “Just fill it out single – zero so you get a big tax refund” to “file exempt so the government doesn’t keep your money all year interest-free.”

I find that most people have no idea that by filling out this form they are explaining to their employer how much to take out of their check. I see people with kids getting huge refunds every year and still having their employer withhold. This money could be paying the bills every week. I see people claiming married – four because that reflects their family size that wind up owing tax every year because their spouse works, too.  Reading the instructions or doing the online worksheet at 

https://www.irs.gov/individuals/tax-withholding-estimator will give you a better idea of how to fill out the form.

What happens if you tell your employer to withhold zero and you will pay your tax bill next April? If you owe less than $1000, it’s ok if you pay it by April 15th. If it is over $1000, they can and will fine you for not paying in through the year.

State Income Tax Withholding

This is very similar to federal withholding, except it is your state collecting money. Most states follow the same procedures for withholding and paying tax as the federal does. Some states have additional taxes taken out. (NJ taxes employees for unemployment, family leave, and disability.) Some municipalities charge income tax. (New York City charges income tax as high as NY state.) Some states, such as Texas, Tennessee, and Florida, don’t have income tax at all.

Other things….

In addition to taxes, other things can also be withheld from your check. Retirement contributions, health insurance payments, child support, garnishments, union dues, loan payments, housing, and many other things can be taken out of your check. If you don’t know what something is, ask your HR dept, your boss, or an accountant experienced in payroll matters.