5.1 Taxes and Your Paycheck

Unit 4: Taxes

Payroll Tax Income Tax Federal Insurance Contribution Act (FICA) Withholding Gross Income Net Income Form W-4 Internal Revenue Service (IRS) Allowance

5.1 Key Terms (there are a lot)

Payroll taxes are placed on income earned by individuals. The amount of payroll tax that is assessed on a person’s income is based on the individual’s total earnings and the tax laws.

Payroll taxes are paid by individual employees and their employers.

Payroll Taxes

Federal Insurance Contributions Act (FICA) tax: The law that requires workers and their employers to contribute to Social Security and Medicare.

1. Social Security Tax: provides benefits for retired workers and their dependents as well as for the disabled and their dependents. (Also referred to as the FICA tax.)

2. Medicare Tax: used to provide medical benefits for certain individuals when they reach age 65. Workers, retired workers, and the spouses of workers and retired workers are eligible to receive Medicare benefits upon reaching age 65.

What is FICA?

Income Taxes: are taxes you pay on most types of income you receive. Income taxes are not a fixed percentage.

Income taxes vary depending upon each taxpayer’s financial and family situation.

You are responsible for calculating the amount of federal income tax you owe.

Income Taxes: A closer look

Your employer collects taxes from each paycheck by deducting or withholding money from your wages.

Simply put withholding: employer deductions from employee’s earnings to pre-pay employee’s taxes.

What is a Withholding?????????

Kelly found a part-time job at a video store that pays $7.50 per hour. She wanted to take home at least $50.00 per week, so she agreed to work seven hours each Saturday. She expected her first paycheck to be $52.50. She was surprised to find it was only $40.39.

Why wasn’t Kelly’s paycheck what she expected?

Because of her payroll and income taxes

Let’s put all this information into a real life example to make sense of it!

What is Kelly’s gross income? Yes, $52.50 (7 hours X $7.50 per hour) Gross Income: the amount you earn

before taxes are withheld.

What is Kelly’s net income? Yes, $40.39 Net Income: the amount you receive

after withholdings are subtracted from your gross income. (also referred to as take-home pay)

Kelly Example cont…..

The amount of income tax you owe depends upon several factors:

Your gross income The number of people you support Other expenses you pay

When you are hired your employer will ask you to complete federal Form W-4, which is required by law.

Form W-4

An allowance is the number that reduces the amount of income withheld from your pay.

The more allowances you claim, the smaller the

amount withheld will be & the higher your paycheck.

VERY IMPORTANT TO UNDERSTAND: The number of allowances you claim will not change the

amount of tax you owe. You alone are responsible for having enough income withheld to cover the amount of income tax you owe!

What is an allowance? (not the one your parents give you for taking out the garbage)

Suppose you claim five allowances on your W-4 when you should only claim one. Will the amount withheld by employers be larger or smaller ?

SMALLER

Based upon you W-4 your employer might withhold $500 from your pay over the year, but you may owe $3,000 in taxes. What happens?

You have to pay the rest of the taxes, $2,500, and you may also be charged interest and a fine because the amount withheld was not even close to the tax owed.

For example:

What if you are withholding too much: Refund by the IRS.

What if you are withholding too little: Send extra tax payments to the IRS Claim fewer allowances

Adjusting your allowance.

Is having more income than necessary withheld from your paycheck a good way to save?

From a financial standpoint NO. Why?If you have more money withheld you

are in essence letting the government use your money for free. You deposited the extra money from each paycheck you could be earning interest on it instead.

Overwithholding as a way to save?

Employers withhold payroll taxes and income tax from employees' pay.

Employers send the amounts withheld to the federal government.

Employees complete Form W-4.

Employers use Form W-4 to determine how much income tax to withhold from employee pay.

Important Basics to Understand:

Complete the first section of the tutorial for payroll taxes & federal income tax withholding:

http://www.irs.gov/app/understandingTaxes/student/hows_mod01.jsp

Concept Reinforcement Homework