This week we’re going to go back to the basics. This is something we all should have learned about and understood in high school. But guess what? A great deal of people still do not understand how income taxes work and they have been working for years!
There are three main types of taxes that are withheld from your paycheck each period: Federal Income Taxes, State (and maybe local) Income Taxes, and FICA (Employee Medicare and Social Security Employee Taxes). Yes, way too many taxes! Let’s get into this:
Federal Income Taxes: So, when you begin a new job, you have to complete a Form W-4. This will determine the deductions from your paycheck. It is so important that you understand how to complete a W-4. Refer to this IRS link if you do not fully comprehend the Form W-4, please! Trust me, you do NOT want to owe the IRS because of unawareness. We want to at the least cover your tax liability. If you end up over paying in taxes throughout the year, then you will receive a tax refund, which is what we all look forward to. The rate is determined based on your income tax bracket and the answers you put on the form.
State (and maybe local) Income Taxes: Each state differs when it comes to taxes. But the general gist is similar to Federal Income Taxes. You will complete a similar document to the W-4 for the state in which you work. It will help determine how much the state will withhold from your check each pay. Fun fact: there are 9 states that do NOT withhold income taxes (I might have to consider moving). However, depending on your city, there may also be local income taxes taken as well. We also want to cover our state tax liability and may have a refund at the end of the year. Or, you may owe. Do not go blind into work…this taxes stuff is not for the weak honey!
Federal Insurance Contributions Act (FICA) Taxes: Unfortunately, we do not get these funds back until we are much older or need healthcare. Employee Medicare taxes makes up one half of FICA. It actually funds the Medicare system in the United States. So, we’re helping people have access to health care. There is a flat rate of 2.9% that is paid. But, 1.45% is only taken from your pay check while your employer matches that rate and pays the remaining 1.45%. The other half of FICA is social security tax. This also has a flat tax rate, which is 12.4% of wages. Employees pay 6.2% while the employer pays the other half. There is a maximum dollar amount in 2021 of $142,800. So, you will stop paying social security tax on earnings over $142,800. Which basically means everyone has to pay these taxes. We are now paying Social Security benefits to the retired from our taxes. So, let your grandparents know you are supporting their current lifestyle (just kidding). But, in the future when we finally retire, the young workforce of the year 2065 will be paying us our benefits!
Bottom Line: Pay attention to your check! Make sure it is accurate. I know, taxes suck. 25% of my salary goes to taxes each paycheck. So, I only take home 75% of what I actually worked for. But, America, am I right? Like, subscribe, reply, whatever you want! Let me know if you want to know more about this topic. Write to you next week.