Every payday when you get your paycheck, taxes are taken out. Your employer uses information you provide to figure your payroll taxes according to Internal Revenue Service rules and sends the money directly to the IRS. The idea is to spread tax payments out over the entire year so that you don't end up owing a lot of money when it comes time to file your tax return.
When you were hired, your new employer gave you a Form W-4 to fill out. After completing the accompanying worksheets, you provided information such as your marital status and the number of exemptions you chose to claim. Called withholding allowances, exemptions reduce the amount of your pay that is used to calculate federal income tax withholding and so lowers the amount of tax taken out of your paycheck. You may claim fewer exemptions than you are entitled to, but not more.
A withholding allowance is a proportion of the annual exemption amount. For example, the figure for 2011 was $3,700. The exact amount of one withholding allowance depends on how often you are paid. For example, if you are paid every week, your employer divided the $3,700 by 52 to arrive at a weekly withholding allowance of $71.15. If you claimed two withholding allowances, that means a total allowance of $142.30 per week. This amount is subtracted from your gross pay to determine the amount that is subject to federal income tax.
Federal income tax is a progressive tax. This means that, as your earnings go up, you pay a higher percentage of tax on each added dollar. The rates are divided into tax brackets. For example, suppose your wages are $650 for a week and you are single and claim two withholding allowances. Take off $142.30 for the allowances, leaving $507.70. There's no tax on the first $40 (using 2011 tax rates). You pay 10 percent of the amount from $40 to $204, which works out to $16.40, and 15 percent of the amount over $204 (another $45.56) for a total of $61.96. If you make more money, the percentage gradually increases until it reaches a maximum of 35 percent. Note that your withholding allowances lower the amount that would have been taxed at the highest rate for your income level.
Federal income tax isn't the only tax taken out of your pay. You also pay Medicare tax and Social Security tax. Both taxes are applied to your gross income before taking off withholding allowances. The rate for Medicare is 1.45 percent. For Social Security it is usually 6.2 percent but was lowered to 4.2 percent in 2011 to help stimulate the economy. Because these taxes are levied on your gross income, the number of withholding allowances doesn't change the amount you pay.
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