Understanding Your Paycheck: Every Deduction Explained

Gross to net, with a real stub

Take a 75,000 dollar salary paid biweekly. There are 26 pay periods in a year, so gross pay per period is 2,884.62 dollars. Here is what typically stands between that and your bank account.

Note the two different taxable bases. Federal income tax withholding is computed after the 401(k), health premium, and HSA come out, so on 2,511.54 dollars. FICA is computed after the health premium and HSA but not after the traditional 401(k), so on 2,684.62. That asymmetry is why an HSA is sometimes described as triple tax advantaged while a traditional 401(k) is not: HSA payroll contributions escape Social Security and Medicare tax as well as income tax. Reproduce your own stub in the paycheck calculator to see how each change ripples through.

FICA: the two flat taxes

Social Security, 6.2 percent. Applies only to wages up to an annual wage base that is adjusted every year for wage growth. If you earn above it, this deduction stops partway through the year and your net pay jumps. It resets in January. High earners who change jobs mid-year can end up over-withheld across two employers and claim the excess as a credit on their return.

Medicare, 1.45 percent. No wage cap. An Additional Medicare Tax of 0.9 percent applies to wages above a filing-status threshold, which for single filers has been 200,000 dollars. Employers begin withholding it once your wages with that employer pass the threshold, which can be wrong for married couples with two incomes, producing either a balance due or a refund at filing.

Employers pay a matching 6.2 and 1.45 percent that never appears on your stub. This is why self-employment tax is 15.3 percent: freelancers owe both halves.

Federal withholding and the W-4 that confuses everyone

The W-4 was redesigned in 2020 and allowances no longer exist. The current form has five steps and works by estimating your annual tax situation directly.

• Step 1. Name, address, Social Security number, filing status. Filing status alone drives most of the calculation.
• Step 2. Multiple jobs or a working spouse. This is the step people skip and the reason they owe money in April. Each employer's default calculation assumes it is your only income and applies a full standard deduction and the low brackets. Two jobs both doing that means both under-withhold. Use the checkbox on both W-4s if there are exactly two jobs with roughly similar pay, or use the IRS estimator for anything more complicated.
• Step 3. Dependents. You enter annual dollar credit amounts here, not a count of people. Getting this wrong by a factor of a thousand is a common and expensive error.
• Step 4. Other income such as interest or dividends in 4a, extra deductions if you itemize in 4b, and additional per-paycheck withholding in 4c.
• Step 5. Signature.

Line 4c is the most useful control on the form. It adds a flat dollar amount to every paycheck's withholding. If you owed 2,400 dollars last April and nothing has changed, dividing by 26 and putting about 92 dollars on line 4c fixes it. You can update your W-4 whenever you want.

A note on refunds: a large refund is not a bonus. It is a return of money you lent the government at zero interest for up to sixteen months. Adjusting withholding to land near zero and directing the difference into savings each month is strictly better, provided you actually save it.

Pre-tax versus post-tax deductions

Pre-tax reduces taxable wages, so it costs less than its face value. An employee in a 22 percent federal bracket with a 5 percent state tax who contributes 100 dollars to a traditional 401(k) sees take-home pay fall by about 73 dollars, because the contribution avoided 27 dollars of income tax. Common pre-tax items:

• Traditional 401(k) or 403(b) elective deferrals
• Health, dental, and vision premiums under a Section 125 cafeteria plan
• Health savings account contributions made through payroll
• Flexible spending accounts, both health and dependent care
• Qualified transit and parking benefits

Post-tax comes out after taxes are calculated and does not reduce your tax bill:

• Roth 401(k) contributions, which buy tax-free qualified withdrawals later instead
• Disability insurance premiums, and paying these with after-tax dollars means any benefit you eventually receive is generally tax-free, which is usually the better trade
• Union dues, wage garnishments, and charitable payroll deductions
• Employee stock purchase plan contributions

You may also see imputed income, a line that increases taxable wages without giving you cash. The classic case is employer-paid group term life insurance above 50,000 dollars of coverage; the cost of the excess coverage is taxable to you. Domestic partner health coverage often produces imputed income too.

Why your bonus looked like it was taxed at 40 percent

Supplemental wages, which include bonuses, commissions, and severance, are commonly withheld using a flat percentage method: a flat 22 percent federal rate on supplemental wages up to 1 million dollars in a year, and 37 percent on amounts above that. Add FICA at 7.65 percent and state withholding and a 10,000 dollar bonus can arrive with a third or more removed.

That is withholding, not tax. Your actual tax on the bonus is whatever your marginal bracket turns out to be for the year. If your marginal rate is 12 percent, you get the excess back at filing. If it is 32 percent, the flat 22 percent under-withheld and you will owe. Either way, no bonus is taxed at a special punitive rate; the number on your stub is an estimate applied by a formula.

Some employers instead use the aggregate method, treating the bonus as if it were part of a normal paycheck, which usually withholds even more because the annualization makes a single period look like an enormous salary.

Hourly pay, overtime, and the numbers to check

If you are paid hourly, convert to an annual figure before comparing offers. Forty hours a week across 52 weeks is 2,080 hours, so 28 dollars an hour is 58,240 dollars a year before any overtime. Do the conversion in either direction with the hourly to salary calculator, and remember that a salaried offer at the same headline number is not equivalent if the hourly job includes reliable overtime or the salaried one includes unpaid extra hours.

Under federal law, non-exempt employees are entitled to at least 1.5 times their regular rate for hours over 40 in a workweek. Two details cause most disputes. First, the regular rate is not always your base rate: nondiscretionary bonuses and shift differentials generally have to be folded in, which raises the overtime rate. Second, some states have daily overtime rules and different thresholds, and state law applies where it is more generous. Check the arithmetic on your stub with the overtime pay calculator if the numbers look off.

State and local lines

State income tax withholding varies more than any other line. Several states impose no personal income tax on wages at all, some use a flat rate, and others use graduated brackets. On top of that you may see city or county income tax, school district tax, state disability insurance, paid family leave premiums, or state-run retirement program contributions. Some of these are employee-paid, some shared, and the specifics change with legislation. If a deduction appears that you do not recognize, payroll can identify it and most of the unfamiliar ones are state-mandated programs.

Read the year-to-date column

The YTD figures are the ones worth checking each month.

• Is your 401(k) on track? Contribution limits are annual. If you front-load and hit the cap in October, you may lose out on employer matching in the final months unless your plan offers a true-up. Check your plan document.
• Is federal withholding roughly proportional? Divide YTD withholding by YTD gross and compare to last year's effective rate. A large divergence early in the year is easy to fix and expensive to discover in April.
• Did Social Security stop? If YTD Social Security wages hit the wage base, expect a mid-year jump in net pay and plan for it rather than treating it as a raise.
• Are your benefits deducting what you elected? Open enrollment changes get mis-entered more often than anyone expects.

One last thing worth internalizing: money that goes into a 401(k) is not accessible without cost. Withdrawing before age 59 and a half generally triggers income tax plus a 10 percent penalty, with limited exceptions, and the 401(k) early withdrawal calculator will show you how little of a withdrawal actually reaches your account. Set the contribution rate at a level you can sustain, and treat the money as gone until retirement.