What to Know About Taxes on Your Paycheck

The amount of taxes taken out of each paycheck can be shocking, but employees need to pay attention to what is being taken out of their paychecks and why. In this post, we take a look at what you need to know about taxes on your paycheck, including how to plan to reduce your tax burden.

By Brandi Fowler

The first thing you might think when you receive your paycheck is, “Why was so much taken out of it?”

Taxes are the obvious culprit, but it pays to know how that system works. 

“A percentage of your gross pay each pay period is withheld to cover [payroll taxes], federal income taxes, FICA contributions (that is, Social Security and Medicare taxes), and any state and local taxes,” according to Moneywise. 

How much you will pay in taxes depends on where you live, earnings, marital status, and more.

“It is important for you to know financially where your funds are going,” Ieasha Bell, CFP said. “When you are working and you hear, ‘Hey, you are going to get $60,000 a year, but you bring home like 45,000,’ you are like, ‘I thought it was 60? What's happening here?’

“Knowing is half the battle. If you are planning, you are planning to win. If you are not planning, then you are planning to fail. And if you can get in your mind that 30 percent will be taken from that salary, then you know what to aim for and how to plan your life.”

Once you up your tax knowledge, you can pay closer attention to the taxes taken from your check, identify where the money is going, and determine how to lessen your tax burden. 

“Although the IRS requires federal tax withholding from our paychecks, taxpayers should be aware of each type of deduction from the paycheck so they can make financial decisions based on their needs and preferences,” President of Landmark Tax Group Michael Raanan said. “For example, the nine states with no state income tax typically see annual positive migration for a reason, and it is not just because of the weather.”

For further paycheck taxation knowledge, how to plan, and more, I talked to certified financial planners Bell, Raanan and Malcolm Ethridge.

Plan to Get the Biggest Refund Possible - and Income Boost

One of the best things you can do when starting a new job is to ask an accountant for guidance before filling out a W-4, Ethridge said. Don’t wait until the last minute. 

“That is one of the advantages to having an ongoing relationship with an accountant versus using one of the online filing services like Turbo Tax,” Ethridge said. “Most accountants are working their butts off between February and the end of May. So, even if you are able to find a new accountant in that window, you are not likely to get all of their attention on your return as a brand new [client].

“Start that relationship in June, July, August, when they have nothing to do, and you can spend an hour at their office or on zoom or whatever, explaining your situation.”

Tax professionals can also help you navigate tax withholding and relatively new aspects of the W-4 like the multiple jobs worksheet (launched in 2020).

You can also work with your payroll department or a tax professional to help adjust the amount of taxes taken out of each paycheck, Raanan said. 

“This may mean a decrease or an increase, depending on your specific situation,” Raanan said. 

Be careful not to withhold too much or too little. 

“While it may feel good to get a large refund during tax season, a refund caused by over-withholding of your taxes may necessitate an adjustment,” Raanan said. 

How Federal Income and State/Local Taxes are Calculated

Federal and state Income taxes make up the biggest portion of paycheck taxes. 

“I think what everyone needs to know is that your payroll taxes are a huge government source of revenue,” Bell said. “So that taxation goes towards helping pay government workers, firefighters, police workers, helps maintain highways, libraries, roads, sometimes schools, programs, the less fortunate.”

The state/local tax percentage depends on location. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming have no state taxes, for example.

“If you're fortunate to live in one of the nine states that don't have state tax withholding, then you don't worry about that portion,” Bell said. “But all the other states have state tax withholding that range from somewhere between three percent to 15 percent.”

California is the highest, but the range is broad depending on the state. States with no local tax get their funding via higher state taxes, corporate taxes, and sales taxes, Bell said. She added that since those taxes are higher than in states with no local tax, it balances out. 

What is FICA and How Much of Your Paycheck Goes to It?

In addition to federal and state taxes, there is a FICA tax deduction on your paycheck. 

FICA (Federal Insurance Contributions Act) is a U.S. federal payroll tax composed of your social security and medicare taxes. Social security taxes are 6.2 percent of your check, and 1.45 percent is for Medicare.

“[FICA] goes into your individual social security bucket when you retire,” Bell said. “It is the portion [employers] deduct from you, but [employers] then send it to the social security administration and they use it to calculate what your benefit will be later on.

“The medicare portion goes towards your medical bills as you get older and after you retire. FICA is paid twice by the employer. [Employers] deduct it first from the employee and then [employers] pay it again. So almost like a match.”

How Allocating Funds for Your 401K and HSA Can Help Your Tax Burden

Health savings accounts (HSA) are employer-sponsored health insurance programs that offer coverage with higher deductibles and low premiums. 

According to Investopedia, it is “a tax-advantaged way to save money." HSA contributions “reduce taxable income, investment growth in the account is tax-free and qualified withdrawals are tax-free.”

Meanwhile, a 401(k) plan is a retirement account employees put funds into. Like HSAs, Contributions to 401(k)s are pre-tax dollars.

“I would highly recommend if you're with a company that's doing 401(k), get in it,” Bell said. “A 401(k) is tax-deductible, meaning that it is not part of your taxable wages. So, if your gross income is $5,000 and you're putting $500 into this 401(k), the federal tax is only going to be taxed on $4,500. So it reduces it and it benefits you.” 

Raanan echoed that sentiment. 

“Contributing to a retirement account can be a good way to reduce the amount of taxes owed,” Raanan said. “The IRS does have restrictions on annual contribution amounts that taxpayers should take note of.

“Health savings accounts are becoming more popular, as they provide taxpayers with multiple benefits such as reducing the amount of tax owed and using the funds for qualified expenses tax-free.”

Seeing the amount of taxes taken out of each paycheck can be frustrating, but knowing how those taxes break down is essential for your financial health. Work with a tax professional on your W-4 and taxes, keep an eye on withholdings, and make contributions to a 401(k) or HSA to help reduce your tax burden. Taking those steps also alleviates stress.

Top Takeaways

What to know about Taxes on your Paycheck

• Work with a financial advisor to fill out your W-4 if possible.
• Keep your tax percentage and post-tax paycheck in mind as you negotiate your salary. 
• Contributing to a 401K and/or HSA helps reduce your tax burden. 
• Pay close attention to the taxes deducted from your paycheck and make sure you are not withholding too much.