Understanding Your Payroll Taxes

payroll taxes understanding

Taxes are inevitable. If you live in this country, you will experience the benefits of what our tax dollars go towards, but also will be responsible for contributing to the funding of those projects, services and initiatives via tax payments. When we work, our earned income is also subject to taxes, often called “Payroll Taxes”. These taxes include federal income tax, state income tax, Medicare and social security.

The Medicare and social security tax are sometimes referred to as FICA taxes. If you are a W2 employee, these taxes are handled through payroll and are taken out of your check in accordance with your income levels and the designations you made on your W4. If you are a 1099 employee, YOU ARE RESPONSIBLE for making these payments quarterly and ensuring you have set aside enough money to cover your obligations for the year. 

Now, let’s look a little bit closer at the different taxes above, to gain a better understanding of where your money in your paycheck is going!

Federal Income Tax with Payroll Taxes

Federal income tax is money that is paid to our federal government based on the amount of money that we earn. It is a PROGRESSIVE system, meaning the more money we make, the more taxes we pay. Tax brackets/rates are based on income levels and each level of income is subject to a higher tax. As the table shows below, the tax brackets range from 10% to 37% and each rate covers a range of income. You pay taxes at the lowest rate and then move onto the next highest rate when that bracket is satisfied. For example, a single individual who makes $40,000 will pay 10% federal income tax on the first $9,950 they make. Then, they will pay 12% on every dollar they make between $9,951 and $40,000. The federal tax system is set up in a manner that you not only pay larger quantities of taxes as you make more money, but also a higher portion of every dollar you earn is going to the government in taxes.

State Income Tax

In addition to owing the federal government income tax, you also owe your state. State income taxes differ from federal income tax though, as every state has a different rate. Some states, such as Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming have NO INCOME tax. Other states, such as North Carolina (among others at varying rates) have a FLAT tax rate of 5.25%. Meaning all income regardless of how much or how little is taxed at 5.25%. Other states have a progressive system like the federal government does and come at varying rates. California has the most aggressive progressive tax rate, where high earners are taxed up to 13.3%! That means someone in the highest income bracket in California will pay 13.3% in state income taxes and 37% in federal income tax. Over half their paycheck is taxed before they even start paying their Social Security and Medicare Taxes!

Social Security and Medicare Taxes (FICA)

Social security and Medicare are two systems that are benefits to American citizens and we pay into and fund them with our earned income. What they will look like 5,10,15,30 years from now is up for debate, but we still pay into them now. FICA taxes are shared expenses by the employee and employer. However, if you are self employed, you pay BOTH the employee and employer portions! Social security is taxed at 6.2% and Medicare at 1.45% or your income for a total of 7.65%. Both the employee and employer pay those percentages, if self employed or 1099, you pay both, so effectively a total tax of 15.3%. Social security and Medicare do both eventually phase out or decrease at higher rates of earnings. 

Better understanding how your income is taxed is imperative while determining your personal strategies for optimizing income and tax efficiency. It is always better to earn more money, but if we have the ability to defer or deduct  earnings or utilize tax advantaged accounts to reduce our current tax obligations, we need to have a good understanding of what the options and situations entail to make informed decisions. 

-Dr. Zach Baker, PT, DPT, SCS . Do you want to chat further? Engage and discuss with Zach on Instagram HERE!

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