Getting a Paycheck

It might surprise you to know that if you get a job earning $600 a week, you don’t actually receive $600 a week. Although your gross income or pay will be $600, you’ll have payroll taxes deducted from each paycheck before you receive it, which include federal, state, Medicare, and Social Security taxes. You may also have voluntary deductions for workplace benefits such as health insurance, life insurance, and contributions to a retirement account. The remaining amount that you’ll have to spend after taxes and deductions is called your net income or net pay.

Finance Tip

Employers are required to pay 50% of FICA on behalf of their employees. If you become your own boss, you must pay self-employment tax, which includes 100% of the Social Security and Medicare tax owed.

When you take a new job, one of the forms you must complete is the W-4. It tells your employer how much tax should be taken out, or withheld, from each of your paychecks. If too little tax is withheld during the year, you’ll owe money to the government’s Internal Revenue Service (IRS) on tax day (which is usually April 15 unless it falls on a weekend or holiday). If too much tax is withheld, the IRS will pay a refund, but you will lose the use of your money until the refund payment arrives. So it is good to have your payroll withholding match the actual amount of tax you’ll owe.

Significant events—such as marriage, divorce, the birth or adoption of a child, buying a home, or taking an additional job—will affect how much tax you owe. Additionally, earning income from savings accounts or investments affects the tax you owe. Any time your personal situation changes, you can file a new W-4 with your employer to make sure the right amount of tax is withheld so you don’t have any surprises on tax day. You can learn more by visiting the IRS website at irs.gov and searching for Publication 919, How Do I Adjust My Tax Withholding?

How Payroll Withholding Works

Employers are required to withhold four different types of tax from your paycheck:

  1. Federal income tax is paid to the IRS for expenses such as salaries of elected officials, the military, welfare assistance programs, public education, and interest on the national debt.

  2. State income tax is generally paid to your state’s revenue department for expenses such as salaries of state employees and maintenance of state highways and parks. Depending on where you live, there may also be payroll deductions for county and city tax.

  3. Social Security tax provides income for eligible taxpayers who are retired or disabled, or who survive a relative who was receiving benefits. The program’s official name is OASDI, which stands for Old-Age, Survivors, and Disability Insurance.

  4. Medicare tax provides hospital insurance benefits to eligible individuals who are over the age of 65 or have certain medical conditions. Social Security and Medicare taxes are collectively called the Federal Insurance Contributions Act (FICA) tax.