Decoding Your Paycheck – Important Financial Terms

Important Definitions

Gross Wages 

• Your gross wages represent your total take home pay BEFORE paying federal taxes, Social Security, Medicare, or contributing to any employer benefits
  • Example 1: If you earn $10/hour and work 80 hours per pay period, your gross wages for the pay period would be $800
  • Example 2: If you earn $12,000/year and are paid monthly, your gross wages for one month would be $1,000
• On your paycheck, you will normally see your gross wages listed in two forms
  • Form one is gross wages with respect to the pay period (bi-weekly, semi-monthly, etc.)
  • Form two is gross wages with respect to the year (year to date – YTD) 

Pay Period

• The pay period represents how frequently you are paid
• Most people in the US are paid on a bi-weekly basis 
  • Every two weeks, or 26 times per calendar year
  • Usually a total of 80 hours are worked during this pay period
• The other most common pay period is semi-monthly, which is twice per month, or 24 times per calendar year
• Other pay periods are weekly, monthly, bi-annually, and annually

Filing Status

• Your filing status determines what federal withholding table you will use to calculate your federal income taxes
• Before 2020, there were usually only two filing statuses
  • Single or head of household
    • Head of household is a filing status that means you earn the majority of your household’s income to maintain the household for yourself and qualifying dependents (usually children or elderly)
  • Married filing jointly 
• In 2020, there are three different filing statuses, but two different withholding methods, for a total of six different withholding tables
  • Withholding Method 1 
    • Standard Method 
    • Part C of Step 2 in IRS Form W-4 is not checked
    • Most common
  • Withholding Method 2 
    • Part C of Step 2 in IRS Form W-4 is checked
      • Part C of Step 2 in IRS Form W-4 can only be checked if one of the following are true
        • As an individual, if you hold exactly two jobs in 2020
        • As a married couple, if you are married filing jointly, both spouses work, and each spouse only has one job (two total jobs) 
  • Filing status within each method:
    • Married Filing Jointly
    • Single or Married Filing Separately
    • Head of Household
  • Further guidance can be found at the links below:
    • IRS Form W-4 (guidance for Part C, Step 2)
    • Publication 15-T (withholding tables)

Pre-Tax Benefits

• Employment benefits you pay for out of your gross wages that ARE NOT subject to federal income tax 
• Examples include:
  • 401k Retirement Savings
  • Health Savings Account (HSA)
  • Health and Daycare Flexible Spending Accounts (FSAs)
  • Medical Insurance Premiums
  • Dental Insurance Premiums
  • Vision Insurance Premiums
•  Contributing to these (especially 401k and HSA) lower your overall tax obligations
• Like gross wages, these benefits will be listed on your paycheck in terms of pay period and year to date (YTD)

Post-Tax Benefits

• Employment Benefits you pay for out of your gross wages that ARE subject to federal income tax 
• Examples include
  • Additional Life Insurance 
  • Roth IRA Retirement Savings
  • Disability Insurance
• Contributing to these DO NOT lower your overall tax obligations
• Like gross wages, these benefits will be listed on your paycheck in terms of pay period and year to date (YTD)

Federally Taxable Income 

• Income subject to federal taxes (gross income minus pre-tax benefits)

FICA Taxable Income

• Income subject to contributing to Social Security and Medicare systems (gross income minus pre-tax benefits except for standard 401k contributions)

Imputed Income (Fringe Benefits)

• This is a confusing subject, but basically, imputed income represents non-cash compensation that is considered taxable
• This income is not actually paid to you, but on paper, is listed as income (in the FICA Taxable Income, and not the Federally Taxable Income) for proper tax calculation purposes
• This figure most likely won’t show up on your paycheck unless you contribute to employer benefits such as Group Term Life insurance over $50,000
• The following article provides a great explanation for further reading
• Like gross wages, this will be listed on your paycheck in terms of pay period and year to date (YTD)

Federal Taxes 

• The amount of money contributed from your gross income to the US Government
• Calculated based on your filing status and your federally taxable income
• Like gross wages, this will be listed on your paycheck in terms of pay period and year to date (YTD)

Social Security Taxes 

• Amount of money contributed from your gross income to the Social Security Administration
• This is usually a fixed percentage that is applied to your FICA taxable income
  • The percentage for this year is 12.4%
  • Usually, the employer and employee each contribute half to this system (6.2% each)
• Like gross wages, this will be listed on your paycheck in terms of pay period and year to date (YTD)

Medicare tax 

• Amount of money contributed from your gross income to the Medicare System
• This is usually a fixed percentage that is applied to your FICA taxable income
  • The percentage for this year is 2.9%
  • Usually, the employer and employee each contribute half to this system (1.45% each)
• Like gross wages, this will be listed on your paycheck in terms of pay period and year to date (YTD)

Withholding Allowance

• Represents a fixed amount of money, which can be used in a manner similar to pre-tax deductions, for reducing an employee’s overall federal income tax obligation
• Can be set through your employer
• The higher the number of withholding allowances, the lower the amount of taxes taken away from your gross income
• The general goal of withholding allowances is to avoid overpaying/underpaying taxes to the federal government
• Withholding allowances were removed in the 2020 IRS W-4 Form
  • To account for this modification, many more tax brackets were added to the tax system in year 2020
  • Instead of two filing statuses prior to 2020 (Single or Married), the new 2020 tax system has three filing statuses (Single/Married Filing Separately, Head of Household, Married Filing Jointly), with withholding allowances already built into the tax tables
    • Appears that 2020’s tax system builds in approximately 5 withholding allowances into the tax tables
• General guidance on how to set an appropriate number of withholding allowances can be found in the 2019 IRS W-4 Form

Take Home Pay

• The amount of money you actually take home after you have contributed to your employer’s benefits, contributed to the US Government in federal taxes, and contributed to the Social Security and Medicare systems
• Gross wages minus pre and post-tax benefits minus federal taxes minus FICA taxes
• Like gross wages, this will be listed on your paycheck in terms of pay period and year to date (YTD)