The Internal Revenue Service describes federal tax as a “pay-as-you-go system.” The idea is to withhold federal taxes from each paycheck so that you have already paid most, if not all, of the taxes you owe by the end of the year. Your employer follows IRS guidelines and uses information you provide on IRS Form W-4 to figure the percentage of federal taxes and Medicare tax to deduct from your gross pay.
Gross Pay and Taxable Earnings
Federal income tax is calculated using only part of your gross pay. Before figuring income tax, your employer subtracts the value of the withholding allowances you claim on your W-4 form from your gross pay to find your taxable earnings. The amount of a withholding allowance depends on the length of your pay period and is adjusted each year by the IRS. For example, the withholding allowance for people paid weekly was $73.15 in 2012. Suppose your gross pay for one week’s work is $600 and you claim two withholding allowances. Your employer will subtract $73.15 for each withholding allowance from $600, leaving $453.70 as taxable earnings.
Income tax is a progressive tax. This means the first dollars of your taxable earnings are taxed at a low rate. The percentage goes up as your income increases in a series of tax brackets. The dollars in each tax bracket are taxed at the percentage rate for that tax bracket. The exact dollar amounts vary depending on your filing status and are adjusted each year. As of 2012, the first dollars of your taxable income were taxed at 10 percent. Dollars in the next tax bracket were taxed at 15 percent. Next are the 25 percent, 28 percent and 33 percent tax brackets. The highest tax bracket is 35 percent.
Social Security Tax
The Social Security tax is calculated as a fixed percentage of your gross pay. Usually the Social Security tax rate is 6.2 percent, but for 2011 and 2012, Congress lowered the rate for employees to 4.2 percent. There is an annually adjusted income cap. For example, in 2012 the cap increased from $106,800 to $110,100. Once gross pay exceeds the cap, no more Social Security tax is withheld. Employers pay another 6.2 percent of your gross pay in Social Security tax, but this is not withheld from your paycheck.
Like Social Security tax, the Medicare tax is a fixed percentage of your gross pay. The percentage rate is 1.45 percent. There is no income cap for Medicare tax, so all of your gross pay is subject to this tax. Your employer pays another 1.45 percent. The employer portion is not withheld from your pay.