Finding Federal Deductions for Income Taxes by bhg10732


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        When you take a job, you accept the wage your employer offers to pay, let’s say $7.50
per hour. You will work hard eight hours a day, Monday through Friday; and then you receive
your first paycheck. You plan to save half and spend the other half. So $7.50 per hour times 8
hours is $60.00 a day for five days which is $300. You open your check and find it is for $225.
WRONG. You have just paid $75 in deductions.

       Twenty-five percent is about the average amount deducted from wages in this country,
and the reason you are studying this unit is that 25 percent is really a huge bit out of your
money and your time. If you work for 35 years, averaging $50,000 per year; you won’t get paid
for almost nine years of hard work and about $262,500 of your earnings. You will put a lot of
time and money into deductions, but you will get some of it back. Do this unit so you
understand why you pay deductions.

                                      GROSS INCOME

      You have just become employed by the Anytown Deli to work as a cashier. You will be
earning $7.50 per hour, working three hours after school each day and eight hours on

      The weekly gross income is figured as follows:

             $7.50 per hour x 23 hours per week - $172.50 per week
             Yearly gross income = $172.50 x 52 weeks per year = $8,970.00

COMPLETE EXERCISE 1 - Calculating Gross Income

                                   PAYROLL DEDUCTION

       When interviewing for a job, your prospective employer will state the salary to be paid
hourly, weekly, biweekly, or monthly. The wages earned for a definite period of time before
deductions are called the GROSS INCOME. For example, the Deli referred to above will pay
you $172.50 gross income per week. As mentioned before, your paycheck will not equal this
amount. There are various sums of money which will be subtracted from your gross earnings.
Such deductions include:

      Fixed deductions (must be taken out by law)
      1.     Federal Insurance Contributions Act - FICA
             (Social Security) or some type of retirement
      2.     Medicare
      3.     Federal Withholding Tax
      4.     State Income Tax
       Flexible deductions (ones you request to be taken out)

       1.     Charity/United Way
       2.     Group Health/Life/Dental Insurance
       3.     Retirement or Pension--above social security
       4.     Credit Union
       5.     Automatic Savings
       6.     Union/Association Dues


       Before the Anytown Deli can hire you, you must have a social security number. As
required by law, your parents obtained this before you were two years old.

       This social security number is used in the following ways:
       1.     by the government and employer to identify individual records of earnings
       2.     by banks to identify checking, savings, and loan accounts
       3.     by individuals for the purpose of filing income tax

       The same number remains with you throughout your life. In the event of loss or name
change, notify the social security office and request a replacement card. (The nearest Social
Security Office can be found in the phone book--in Peoria it is located on Pioneer Parkway.)
Be sure to indicate your social security number on the request. The card will be replaced;
however, the number will remain the same.

       History: The Federal Insurance Contributions Act (FICA), better known as social
security, was passed in 1935 as a result of changes in our society which would no longer
enable the average individual to provide for himself/herself after retirement.

       Once the United States was a society with individuals independent and capable of
producing their own means of livelihood--food, clothing, and shelter. It has now become an
industrial society dependent upon others for producing daily needs in exchange for money.

       This industrial society is highly mobile; thus, the family unit no longer stays together
generation after generation. Children are moving miles away from their parents and can no
longer fill the obligation nor responsibility of caring for their elderly. Furthermore, the elderly
expect (and are expected) to be financially independent of their children. In addition, the
lifespan of the average person has increased. People now live well into their seventies,
eighties and nineties.

       It is not the intent of social security to provide the only income after retirement, but
rather it is meant to supplement other incomes--savings, investments, etc. When passed, the
major purpose of the Federal Insurance Contributions Act was:

       To eliminate hardship on the aged, survivors, and disabled by providing minimum
       income for all citizens covered by the program.

       Provisions: There are two parts in the Federal Insurance Contributions Act. The first
part was passed in 1935 and the second part in 1966.

        The first part of the act, Old Age, Survivors, and Disability Insurance is paid for by a tax
placed on the earnings of the employee and a tax on the employer to match that amount paid
by the employee. Payment to social security is mandatory and the funds provide for retirement
payments, payment to family members in the event of the employee’s death, and disability
payments if the employee is injured on the job or has a physical or mental disability as a result
of his/her work.

      The second part of the Social Security act established “Medicare,” which is hospital and
medical insurance.

       The hospital portion is mandatory like the 1935 provisions of social security, and it is
paid by the employer and employee in equal amounts. When you are retired, it will cover a
major portion of your hospital bills, nursing home care, visitations by medical persons, such as
nurses, physical therapists, etc., other than doctors.

      Medical insurance is voluntary, and retired people who use it must pay a small monthly
premium which is being increased as costs go up. The federal government matches these
monthly payments. Medical insurance pays doctor bills, special tests, medical equipment, and
ambulance costs. Prescriptions are not covered by either hospital or medical insurance.

       None of the programs under social security will fully pay or cover the costs of
retirement, survivors insurance, disability, hospital, or medical care. However, it does pay for a
portion and thus helps to defray the financial burden for the employee.

       When you get ready to collect your social security, you must request your benefits.
THEY ARE NOT AUTOMATIC. Insured persons or survivors of insured persons should check
with the local social security office when: a) insured reaches retirement age of 62 or 65; b)
insured reaches 72 years of age if the yearly income was higher than allowed for under social
security at age 62 or 65; c) disability occurs prior to age 65; d) a family member dies who was
covered by social security.

       Financing: The deductions for FICA (social security) and Medicare are calculated by
multiplying the percentage rate times the Gross Income. The following examples illustrate how
deductions are figured at the 2009 rate of 6.20% for FICA (social security) and 1.45% for

       Susan earned $865 during the summer. $53.63 was deducted from Susan’s
       earnings for FICA (social security) and $12.54 for Medicare. Susan’s employer
       also contributed $53.63 for FICA and $12.54 for Medicare on her behalf.
       ($865 x .062 = $53.63 and $865 x .0145 = $12.54)

       Chris’s gross income for the year was $18,500. He had $1,147.00 deducted
       from his salary for social security and $268.25 for Mediare. His employer also
       contributed the same amounts to Chris’s social security account.
       ($18,500 x .062 = $1,147.00 and $18,500 x .0145 = $268.25)
        Referring back to your job at the Anytown Deli, your social security deduction would be
as follows:

       1.     Your weekly gross income was $172.50
       2.     Your weekly deduction for social security was $10.70
       3.     Your weekly deduction for Medicare was $2.50
       4.     Your yearly gross income was $8,970.00
       5.     Your yearly deduction for social security was $556.14
       6.     Your yearly deduction for Medicare was $130.07
       7.     The yearly amount your employer would pay into your social security account
              would also be $556.14
       8.     The yearly amount your employer would pay into your Medicare account would
              also be $130.07

COMPLETE EXERCISE 2--Calculating Social Security & Medicare Deductions


        History: The first federal income tax was enacted in 1861 to finance the Civil War. It
remained in effect for eleven years. The present tax law was authorized in 1913, with the
ratification of the 16th Amendment:

       The Congress shall have power to lay and collect taxes on incomes from
       whatever source derived, without apportionment among the states, and without
       regard to any census or enumeration.

        Financing: Upon becoming employed, your employer will have you complete an
Employee’s Withholding Allowance Certificate, most frequently called a W-4 form. Each
person is entitled to claim one allowance for each person dependent upon him, including
himself. You do not have to claim your allowance. The advantage of not taking all or any of
the allowances to which you are entitled is that more is deducted from your check than is
actually required, and you will probably receive a refund after you file your tax return at the end
of the year.

       This is what the money you pay into federal income tax goes for: a) benefit payments to
individuals (welfare, etc.); b) grants to states and localities; c) national defense; d) net interest
on the national debt; 3) other federal operations.

       From 1913 to 1943, taxes were computed for the year and credited to each taxpayer,
who in turn would either pay the full amount at once or elect to pay it in quarterly installments.
Due to the fact that the people would spend their earnings upon receiving them and therefore
had no funds available to pay their taxes, and as a result of the tremendous national debt
caused by World War II ($350 billion dollars/10 times the cost of WWI), Congress, in 1943
enacted the new policy of “pay-as-you-go.” This is the present policy and the reason for the
federal withholding tax deduction on each paycheck.

     With government’s “pay-as-you-go” plan, you will always pay federal income tax.
However, if your gross income in 2009 is less than $5,350 and you had no savings account
interest, the total amount deducted from your paycheck will be refunded by the Internal
Revenue Service (IRS), provided you file for a tax refund by April 15, 2010.

        If your total income is less than $5,350 and you have no savings account interest, this
also means that you are not required to have any federal income tax withheld from your
paychecks. When you fill out your W-4 form, you simply check the box stating that you are
exempt from paying tax. This means, of course, that you must know ahead of time that you
will not earn more than $5,350 during the year and have no savings account interest. If you
earn less than $5,350 and you do have income tax withheld from your checks, you must fill out
an income tax return before April 15 in order to have your tax refunded to you.

       In order to calculate the amount of federal income tax to be withheld from a paycheck,
tables prepared by the federal government are used. Each company keeps on hand such
tables which are specially selected for their particular pay period (weekly, monthly, bi-weekly,
etc.) Many companies have computer software which automatically figures the deductions.

       Let’s go back to your job at the Anytown Deli. When you are hired, your employer
would have you sign a W-4 form. This shows how many allowances (deductions) you are
claiming for your withholding tax. (Read the top of the W-4 form for more explanation.)

      Using the weekly income of $172.50 from your job, the following would be the
procedure for finding the amount of federal income tax to be withheld:

       For this example, we will assume that you completed the W-4 form and indicated one
allowance for federal income tax. Refer to the tax tables attached to the unit instruction sheet.
Look down the column headed “and the wages are--at least” until you come as close as
possible (but not over) your weekly gross income of $172.50--this would be to the number
“170.” The second column “but less than” will indicate the correct range--in this case “175.”
Your weekly gross income was $172.50, which falls in the range between “170” and “175.” (It
was at least $170, but less than $175.) If your income had been $175, you would need to go
to the next step on the table.

      On step “170-175” go across to the column which matches your claimed allowance of
“1.” Here you find $5, the amount of federal income tax to be withheld from your paycheck
each week. If you were claiming zero allowances, you would have $12 deducted from each

COMPLETE EXERCISE 3--Calculating Federal Withholding Tax

                         FIXED DEDUCTIONS--STATE INCOME TAX

       Most states and several cities impose a tax on personal income. This tax takes the
place of a sales tax or is in addition to the sales tax. (Illinois State Tax is in addition to the
sales tax.) The Department of Revenue for the state handles all questions regarding the
state’s tax program. State income tax/sales tax enable the state government to obtain its
monies to finance state programs such as education, highway construction, and public welfare
(unemployment, welfare, aid to homeless children, handicapped, and crippled), transportation,
health, hospital, and urban renewal. State income taxes are withheld from payroll checks in
each state that charges the tax. In some states the rate increases as the taxpayer’s income
goes up.

       In Illinois, the state income tax is set at a fixed percentage which is multiplied times the
gross income of the individual. The tax is deducted from each paycheck. The present
percentage rate for Illinois state income tax is 3.0%.

       Again referring to your job at the Anytown Deli, the amount of state income tax to be
withheld each week would be $5.18 ($172.50 x .03 = $5.18)

COMPLETE EXERCISE 4--Calculating State Income Tax

                                 FIXED DEDUCTIONS-REVIEW


       Your weekly gross income is $300.

              Social Security: Current rate of 6.2%
                     ($300 x .062 = $18.60

              Medicare: Current rate of 1.45%
                    ($300 x .0145 - $4.35)

              Federal Withholding Tax: Use tax table, assuming one allowance on W-4 form =

              State Income Tax: Current rate of 3.0%
                     ($300 x .03 = $9.00)

      The total of these four--$52.95 is the amount deducted from your paycheck for fixed

COMPLETE EXERCISE 5--Calculating Fixed Deductions

                                    FLEXIBLE DEDUCTIONS

      Many employers offer to withhold monies from paychecks as a service to their
employees. These are flexible deductions and might include any or all of the following:

        United Way--Rather than making several donations to various charitable organizations,
(March of Dimes, American Cancer Society, Heart Foundation), you might wish to make a
donation monthly to the United Way. They in turn will divide the donations among the many

      Group Health and/or Life Insurance--Frequently the company you work for will offer a
group health and/or life insurance program of which you may or may not wish to take
advantage. Keep in mind that group insurance usually costs you less. Some companies may
pay a portion of the insurance premium, with you paying the remainder.

       Retirement Fund/Pension--Some companies will offer their employees a retirement fund
plan on a voluntary basis, and with other companies it will be mandatory or a fixed deduction.
This often depends upon the occupational field. This would be in addition to social security,
which is mandatory for almost all occupational areas.

      Credit Unions--Various companies will withhold money upon your request either as a
savings for you or to pay back a loan you have taken out with your credit union. Such credit
unions are able to make loans to their members at a substantial interest savings.

      Automatic Savings--Many people find it easier to have the company deduct a
designated sum of money from each paycheck and deposit it into the savings account for

      Union/Association Dues Deductions--Allows for you to have your yearly dues divided
into monthly payments and deducted directly from your paycheck.

       Your employer may offer some, all, or none of these flexible deductions. You will need
to select those in which you wish to participate.

                                        NET INCOME

       Having started with your “gross income” and having systematically withheld deductions,
you have now arrived at a second, and noticeably smaller income called your “net income” or
“take-home pay.” Always check your paycheck for errors. Be sure your employer has
deducted the correct amounts, and be sure you understand the deductions being taken out of
your paycheck.

COMPLETE EXERCISE 6--Calculating Net Income


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