Understanding the Taxes in Your Paystub
Getting paid through payroll provides serious benefits both in the short and long-term. First, receiving paystubs and getting a W-2 at the end of the year gives you income verification which helps you qualify for loans, healthcare subsidies or renting an apartment. It also provides critical safety nets like unemployment, which is 100% employer paid.
Let’s do a quick walk-through of how your wages are taxed and how your W-4 affects your bottom line.
When you look at your paystub, note that your gross pay is before taxes and your net pay is what you take home after taxes.
Here are the taxes you always see on your paystub:
Social Security
Every time you get paid, you are earning federal credits that will contribute a portion to your retirement. You need a minimum of 40 credits to even qualify for social security (you cannot earn more than 4 in one year). Your earnings get averaged over 35 years, so every year you work with a legal paycheck matters. On top of that, did you know that your employer matches what you pay? Read how social security works.
Medicare
This is a federal health insurance program that will give you access to medical treatment and ensure better health security when you are 65 and older. You don’t see the employer taxes on your paystub, but your employer matches this tax as well. Read how Medicare works.
Federal Income Tax
Your earnings each year are taxed progressively at different rates. For example, the first $9,875 is taxed at 10%. Then the earnings between $9,876 and $40,125 is taxed at 12%. And so on.
Two factors make a big difference in the tax you pay: your filing status and number of dependents. The W-4 form allows you to specify these and other details to calculate the amount of tax to withhold from your paycheck. Here’s a step by step guide to filling out the form correctly. You can update the W-4 form any time during the year to update your withholding.
If you have kids or dependents, you might qualify for the Earned Income Tax Credit (EITC) if your wages for the year are below a certain amount. Dependents and marital status affect the credit amount significantly, and the average tax credit is $2,400. The IRS says many people who are eligible for this credit fail to claim it on their tax return!
You can claim an exemption from withholding any money if you did not owe tax during the previous year and expect to have zero tax liability in the next year.
Unemployment Insurance - Not shown on your paycheck, but so important!
100% Employer Paid
Because you are being paid correctly and legally, your employer is paying unemployment tax. Unemployment protects you if you ever get let go through no fault of your own, and can be a critical safety net as you look for a new position. The current coronavirus crisis has shown how important qualifying for unemployment is. Did you know that people who got laid off due to the coronavirus received an additional $600/week from the federal government on top of the state amount?
Here are taxes that some of you see on your paystub, depending on where you live:
Paid Family Leave (CA, NY, WA, MA)
States differ in how this program is managed. If you work in a state that offers this benefit, that means you can receive partial wage replacement when you need to care for a child, parent or other immediate family member.
Disability (CA, NY)
If you get ill or injured off the job, some of your wages can be replaced through state disability insurance, as long as you were paying into the program beforehand (i.e., being on payroll). In CA, you can receive up to 52 weeks for disability, and in NY, up to 26 weeks.
State Income Tax (CA, NY, VA, ID, MI, MA)
Every state is different.
In California, it’s progressive taxation. The first $9,875 is taxed at 10%. Then the earnings between $9,876 and $40,125 is taxed at 12%. And so on.
New York is also progressive in how they apply state tax, starting at 4% for the first $8,500 earned, and going up a little higher from there as you earn more. If you live in NYC or Yonkers, there is also city income tax.