When teenagers first get a job they are often shocked to see how much tax is withheld from their paycheck. Often the highest amount withheld is not on the state or federal tax line, but on the FICA line. This usually results in the first question asked by teens about their summer job pay, “Who is FICA?”
Let us get FICA out of the way. In brief FICA is paid from every worker into Social Security. What is paid into FICA or Social Security today is paid out today. You are not paying into an account that is yours alone. You are supporting the estimated 61 million people who are currently receiving Social Security benefits. Yes, in theory this includes yourself if you are actively receiving Social Security Disability Insurance (SSDI) benefits. Supplimental Security Income (SSI) benefits are not actually paid from FICA taxes however, which is a topic for a whole different article.
The FICA percentage is set by congress and your portion as an employee is 6.2%, and your employer also pays 6.2% for a total Social Security tax of 12.4%. Your check also has a Medicare line which pays for the Medicare program. This rate is 1.45% for you and another 1.45% for your employer for a total Medicare rate of 2.9%. Therefore, on pay day around 7.65% of your check is taken out for Social Security and Medicare. Your employer also pays 7.65% for a total FICA and Medicare rate of 15.3%. This total rate is paid in full by persons who are self-employed instead of being split between the employer and the employee. You cannot adjust these numbers; what you can adjust is your income tax withheld.
If you are a W-2 employee, the amount withheld for your income tax is determined by the number of exemptions you claim. It is a complex math formula, but is shortened to the exemption number that you fill out on your form W-4. If your employer has never had you fill out a W-4 then go to the IRS website and get the form (opens new window), fill it out and give it to your employer.
Your exemption number is going to depend on a range of factors, but in general you’ll probably end up with 1 to 7 exemptions. This number determines how much income tax is withheld from your paycheck each month, and often results in a refund on your federal tax return. However, you are urged to rethink the refund. It is effectively an interest free loan to the government. you need to put more money in your pocket over the course of the year. It is better to get no refund or owe a few dollars than get a massive refund based on your withholding. You can use that W-4 to put more money in your pocket each time you get paid.
The W-4 Exempt Method
Here is the biggest secret of income tax withholding that everyone can take advantage of. If you received a refund in the most recent tax year, open that W-4 form that you downloaded and enter your name, address, social security number, and check the appropriate box on line 3. Then on line 7 write “EXEMPT”. This will drop your income tax withheld line to 0. It will also probably fluster your HR department as most of them have never seen this used, but draw their attention to the instructions at the top of the form which clearly tell you how to enter “EXEMPT” on the form. Do not tell HR that you received a tax refund as that is not something they need to know, just tell them that you are eligible under the instructions at the top of the form. IF you get serious push back just say that your tax advisor advised you to fill the form out that way.
IF you want to get a recommendation from the IRS for how many exemptions to claim you will need to have a copy of your most recent pay stub handy and use the Withholding Calculator (opens new window). Which will take the data from your most recent pay stub, and tell you if you are having to much tax withheld, or in some cases not enough. The final page from this calculator will also tell you to use the exempt method from above if you have already met your tax obligation for the year.
The IRS, contrary to popular opinion, does not want you to owe them and at the same time they want you to have as much of your paycheck now as possible.
This is a fairly simple process, but if you find it complicated or just want to make sure you are entering the right information; reach out for a free consultation. You will receive a free no obligation evaluation of your income and your withholding along with a simple tax plan for the current tax year.