Calculating federal payroll taxes is easy once you understand a few concepts that are fundamental to the earnings you receive regardless of whether you’re salaried, paid by the hour, or a contractor who has chosen to have deductions applied. This article breaks down how the federal payroll taxes seen on employee pay stubs are calculated.
How Federal Taxes Affect Different Types of Employees
When calculating your taxes, the type of employee you are – salaried, hourly, or contractor, isn’t nearly as relevant as the amount of income you generate. The exception, of course, is that contractors and other individuals who typically don’t have taxes retained, will have a value of zero for the federal tax withheld unless they specifically request otherwise.
Federal income deductions are levied among citizens based on the amount they generate annually. The lower the income, the smaller the tax rate that is applied. As of 2016, anyone with an annual income over $2,250 must have federal taxes deducted from their income. Salaried employees, those who generate a set earning amount annually, will have a set amount deducted in federal taxes each pay period. Hourly employees, however, will have a federal tax rate that is projected based on the amount of earnings they have generated in their previous pay periods. As the year progresses, employers are better able to gauge the total amount they anticipate the employee will make based on their pay frequency and the number of hours they typically work during a pay period.
How Pre and Post Amounts Affect Deductions
Pre and post deductions are additional factors that change the amount of federal taxes that are withheld. As stated before, federal deductions are based on the amount of gross income earned. The more you earned, the more you pay in taxes. With pre-tax deduction amounts, you subtract the pre-tax amount from your gross income before the federal tax rate is applied. The end result is that you pay federal taxes on a lower amount and hence, you don’t pay as much. Pre-tax amounts traditionally include some retirement savings plans, health related deductions like dental, and college savings plans to name a few. Post-tax deductions are the remaining gross amount that taxes are applied to once all of the pre-tax amounts have been subtracted.
What is the Federal Insurance Contributions Act (FICA)?
Other federal deductions that are paid by salaried and hourly employees at every level include FICA, the Federal Insurance Contributions Act, which appears on each pay stub as two distinct entries. The first entry represents the social security tax and the second entry is the Medicare tax, sometimes referred to as OASDI. Both taxes are applied at a flat percentage rate with Social Security at 6.2% and the Medicare tax at 1.45%. Whereas a cap exists on the amount of social security that can be withdrawn, no such limit is present for the medicare tax. The more you earn, the more you pay.
Understanding how to calculate your federal taxes is easy once you:
1. Identify the gross income amount
2. Distinguish between pre and post deductions that are being removed from your earnings.
3. Subtract the pre-tax amounts from your gross income.
4. Apply the federal tax rate, Medicare tax, and the Social Security tax to the gross income earned.