This week, Paula and Jon are joined by Tricia Chau of Payroll Vault, for a walk through the deductions that come out of your paycheck. The amount that is deducted from your paycheck can be quite surprising!
First is the FICA tax, which stands for the Federal Insurance Contributions Act - which includes Social Security and Medicare taxes.
Next, we break down deductions, both voluntary and involuntary. Federal and state withholding can depend on what you designate on your W4 form. Tricia explains how the W4 form has recently changed, to make it more about income and less about exemptions. Regardless, keeping this form updated, especially when you have a major life event, is crucial in making sure the right amount of taxes is being deducted from your paycheck.
If you have questions about this, talk to your accountant, CPA, or financial advisor - this is not something you should be discussing with your employer.
Voluntary deductions can include health insurance, 401k and other investments, and health care if related to a 125 plan, which Tricia explains.
How important is it to understand your deductions and make sure they are being taken out correctly? Tricia shares some horror stories of what can go wrong.
Tricia works with employers at Payroll Vault, and you can find her at https://payrollvault.com/178 or via phone at 248-833-6400.
To reach Paula, you can email her at paula@paulachristine.com
Paula: Hi, welcome to Beyond the Paycheck. I'm Paula Christine. So do you remember when you got your first payroll check and you had all those things that came out and you didn't know what they were? There were so many deductions you thought you were getting, $200 a week. By the time you were done, you only got $150.
So I've asked Tricia Chau from Payroll Vault to come in and talk to us about all those things that come out of your taxes. So welcome Tricia.
Tricia: Thank you, Paula. Thanks for having me. Great to be here.
Paula: I remember, getting my first paycheck and being really surprised at, how many things were taken out and I had to have this discussion with my kids when they got their first paycheck.
But I even today know people that really don't understand what all of those things are that are being deducted. So let's just talk about what those are. So I know the first one that we see. And I get a lot of questions on, is the F I C A tax? What is that?
Tricia: That is the FICA tax, and that stands for the Federal Insurance Contributions Act, and that includes your social security and your Medicare taxes.
Paula: An employer pays a portion and you pay a portion. How does that work?
Tricia: That is correct. The employer and employee both pay an equal share of the tax. So for your social security, you're each paying 6.2% on taxable wages and there is a threshold for the social security and then you're also paying your equal share of the Medicare tax which is 1.45%.
And that does not have a wage threshold or a wage base limit.
Paula: So I know myself cuz I'm self-employed and so is Jon, my producer. We have to pay all of that ourself.
Tricia: Yes. If you are self-employed, you're paying both.
Paula: It really sucks. That's, it's quite a bit of taxes that we have to pay.
Tricia: It is, in addition to the FICA taxes, there are three main areas that you're gonna see on your paycheck. You're gonna see your earnings and that can present as either an hourly rate of pay, a flat amount salary amount. It could be based on piece work commissions, a flat fee or shift differential.
So you're gonna see an earning section. And sometimes that can also include memo calculations or Employer contributions to your 401K or retirement a match earning.
Paula: Okay, so hopefully everybody's contributing to their 401k.
Tricia: Yes. You'll also see a deduction section, and that typically will include both voluntary and involuntary deductions.
So obviously the involuntary deductions are the ones required by laws. Perhaps some court ordered garnishments. And then you'll also see some voluntary deductions there as well.
Paula: Let's talk about the federal and state withholding. So I just know briefly from being in financial services for most of my life that, and I don't even know if you can even talk on this, but I'm gonna talk about it briefly and feel free to chime in, that when you look at your paycheck, the more you work, the larger your federal deduction can be because you might fall into a different tax bracket as you're going forward.
As you're working, you'll see more and more being taken outta your paycheck the more and more that you work.
Tricia: Yes. The income tax withholding really is based on several factors. It could be the amount of wages that you earn. It can also be based on your tax filing status that you designate on your W4 form.
So it's really important for employees and employers to encourage their employees to review their pay stubs on a regular basis and to update their W4 forms as life changes occur to make sure that they're withholding matches what their tax obligations are expected to be at the end of the year.
Paula: And I think for most people, if you are getting a huge refund, that would tell me that your withholding is probably incorrect.
Tricia: Yep. So typically there are a lot of tools out there. I think the IRS has a publication 505. There is a tax withholding app that you can do an estimator. The W4forms themselves come with tax estimation worksheets, and so you really can get pretty close. But there are a few pitfalls that people can fall into when they are filling out their W4 form that could cause them to overpay for underpay, and that's typically has to do with their tax filing status as well as not filling in on their W4 form, whether another spouse or someone in their household also works, which can really jump their income into a higher tax bracket.
Jon: Let me jump in here for a second because I wonder sometimes I know there are people that wanna try to get that number to as close to zero on either side as possible and then, and not have to owe money and not have to get a huge refund come tax season.
But aren't there some people who will, choose their withholding based on the fact that, at least this is true to me when I was younger. I'm not that great with money. I'd rather have the government take more now so I can get a refund so I don't blow it on something stupid during the year.
Paula: A lot of people like that refund because they use it for vacations or use it for their summer taxes.
A lot of people like that. I personally don't wanna give the government any more than I have to, but if it's a great savings tool for some.
Tricia: A lot of people will elect to do that because they would rather have the refund than an unexpected tax bill at the end of the year.
Paula: But you know that W4 form, just saying it's not easy.
Tricia: No, it's not. They just recently updated it as well.
Paula: To make it easier or to make it harder?
Tricia: The tax laws changed so it no longer asks you for personal exemptions, so they've changed it slightly. So now you're looking at the filing status, whether you have another wage earner in your household that will apply to your tax obligation. They've just restructured it so that it's less about exemptions and more about what status should I file at and do I need to have. There are places, I think step two, where you can specify additional taxes that you'd taken out, which in the case of someone who also has a spouse working, they may want to do that because their spouse's income may jump them into a higher income tax bracket.
And so they may actually be under withholding in that case unless they specify that an additional amount be taken out of their paycheck.
Paula: Or we could all just call our accountant or CPA or whoever does our taxes.
Tricia: Yes. That is a great idea.
Paula: That would make it much more simple.
Tricia: Yeah. Employers or payroll providers should never advise an employee about how to complete their withholding forms.
It's always a great idea to contact your accountant to get a full financial picture of what your obligation should be at the end of the year, and to get your withholding as close to that as possible.
Paula: So state withholding is basically just whatever the state income tax is, and every state is different, correct? There's nothing need to be calculated there. It's just a, normally it's just a flat percentage.
Tricia: Right. The only time that could potentially change is you have gross wages that you've earned and then you have taxable wages. Those aren't always necessarily the same number your deductions can have an impact on the amount of wages that are actually taxed.
Typically that affects primarily your federal income tax and the FICA. There are only certain deductions that drop your taxable wage down for FICA, and that would be something like a 125 plan, pre-tax, medical or dental deduction, HSA health savings account or something like that. And there are some instances where it would reduce your taxable wage. For state taxes as well, but that's a little less common. It just depends on your state.
Paula: So those are all the involuntary. So those are the things no matter what you have to have taken out of your paycheck every week. Voluntary is like your health insurance, your 401k, that type of stuff. And actually we just talked to Angela last week.
I believe in on a lot of those benefits and what they mean. So you might wanna go back and listen to last week's podcast. So you have your involuntary and your voluntary deductions. Is there anything else that comes out of your paycheck?
Tricia: You may also see on your paycheck, in addition to the earnings, deductions and taxes you may see other items on your check, such as leave accrual balances or things like that.
But typically your deductions are going to be voluntary or involuntary. Your voluntary or anything that you opt in. So like a retirement plan, medical, dental. It could include uniform garnishments. So some employers require that their employees purchase their uniforms and the employee rather than paying upfront will elect to have that deducted from their paycheck over time.
Paula: Tricia, are there any common misconceptions or misunderstandings that employees have when looking at their paycheck?
Tricia: It's all pretty straightforward. There's a lot of nuance and variables, the taxability of wages that can get a little confusing. So when an employee is reading their paycheck, it can get a little confusing because, for instance, there was a scenario where an employee was questioning the wages that were on his W2 form at the end of 2022, and it was significantly less than what his actual annual salary should have been.
So it's just really important to encourage your employees to review their information, their pay stubs, their paychecks, and to help educate them on how to read these, because it really does help build that trust for the employer employee relationship. So taxable wages I think can get a little confusing for some employees.
Some of your deductions may reduce the amount of wages that are taxable for that specific tax. It's very rare that anything would reduce your taxable wages for FICA. However, it does get reduced when you have a plan 125 deduction, which is some of your pre-tax health benefits. However, just the individual income tax, so your federal and withholding will reduce for your 401k.
Anything you contribute to your 401k, it's still going to be FICA taxable, so to speak. So your Social Security and Medicare tax will still apply to that amount you're contributing to your 401k. However, anything you're contributing perhaps to a health savings account or anything that is tied to a Plan 125 would also reduce the amount of taxable wage for your social security and Medicare taxes.
So a lot of different numbers.
Paula: Yeah, I didn't know that one. I didn't know that Health savings accounts reduces your..
Tricia: If they're tied to plan 125. So that's basically a tax code. So it has to be managed so, there's a little bit of a cost and management to the employer but the employer and employee both benefit because the taxable wages are reduced.
And just for you guys to know, I think the two common misconceptions are what I talked about a little bit earlier, where I had the scenario happen to me where an employee contacted the employer and said, hey, there was no federal income tax withheld from my checks the entire year. I'm at my tax accountant's office right now. And I have a huge tax bill because nothing was withheld. And come to find out, her husband also had an income that was in a significantly higher bracket. And the reason the federal income tax wasn't withheld from her check is because she had filed her status as a married filing jointly, and her income for the year was below the deduction threshold. So zero tax was withheld.
Paula: So her income was below $25,000.
Tricia: It was below the $27,700 threshold for married filing jointly from the deduction. Tax was not withheld throughout the year, and because her husband, her spouse had a much higher income, she was jumped, her status was married, filing jointly. It thrust her into a much higher income tax bracket, and so she actually owed taxes on her income.
Paula: That is a good point about when you are filling out those forms that you need to take into consideration your spouse's income. Like you said, a woman made t let's just make up numbers, her $25,000 and let's say her husband made $200,000. Technically the amount that should be taken out of her paycheck. Should be based on a $225,000 income, right?
Tricia: The combined income. So when employees are filling out their forms, that's why the W4 forms were redesigned, was to kind of account for that. There is a section in step two to specify any additional withholding that you want taken out to compensate for an additional income in your household so you don't fall into that scenario where you have this unexpected tax bill at the end of the year when filling out your W4 form, you really need to keep in mind what's for my household and how I'm filing, what is my full tax obligation and how am I gonna fill out this form to make sure that I'm hitting that zero, so to speak.
As Jon said, I'm not paying too much, I'm not paying too little, and that's when it's really good to use one of the IRS provided worksheets to estimated tax worksheets or to contact your CPA to help you fill that form out because it's really important. And an important thing to know for employees is that they can fill out a new W4 form to update your tax filing status at any time.
So anytime there is an life event change, divorce, marriage, a spouse is no longer working, or a spouse who wasn't working has just gotten a job that is a great time to fill out your W4 form again and to update that information so you do not get that unexpected tax bill at the end of the year, or you're not overpaying.
Paula: Right. We all just had our taxes done couple weeks ago or a month ago, whatever it was. If you've paid too much or you out, it shouldn't be something that you call whoever prepared your taxes and asked them, do I have the right filing?
Tricia: Correct. And it's a great idea for employers to every year remind their employees that it is an option for them to ask them, has there been any changes?
And to please encourage them to submit an updated W4 if they can. It really does go a long way. In helping establish that strong employer employee relationship.
Paula: Yeah, that makes sense. If you know somebody that has a baby or they just got recently divorced or married and they have to change things anyway, like your beneficiary would be a great thing to change at that time too.
Or maybe your deductions would be also something to consider.
Tricia: Yes.
Paula: Thank you Tricia. I know that you work with the employer and not the employee. So if there's an employer out there that has any payroll questions or would like to outsource them, how can they reach you?
Tricia: Yes. They can reach me via my website at payrollvault.com/178 or they can call me at (248) 833-6400.
Paula: Now do you work with people all over the country or just in Michigan?
Tricia: All over the country. Any employer in any state.
Paula: Great. Great. Thank you so much. I learned a lot today. There is things that I didn't know. So thanks again for being with us today, and if anybody needs to reach me, they can reach me at paula@paulachristine.com or check out the website at paulachristine.com. Thank you again.