Key ideas

1. Income tax and payroll tax are different taxes. Income tax depends on your total income for the year. Social Security and Medicare take a flat 7.65% of each paycheck.
2. Withholding is a prepayment, not the final bill. Your employer sends tax in from every check. Your return compares that with what you owe: a refund or a bill.
3. Self-employed workers pay both payroll halves. A 1099 worker pays 15.3% for Social Security and Medicare and sends in income tax themselves, usually four times a year.

Vocabulary

Tax withholding

Income tax your employer takes out of each paycheck and sends to the IRS for you, as a prepayment of your yearly tax.

Form W-4

The form you give your employer to set how much federal income tax is withheld from each paycheck.

Standard deduction

A flat amount the IRS lets you subtract from your income before tax is figured, if you do not itemize deductions.

Tax bracket

A range of income taxed at a certain rate. US federal income tax has 7 brackets, from 10% to 37%.

Self-employment tax

Social Security and Medicare tax for people who work for themselves. It is 15.3% on 92.35% of net profit, on top of income tax.

401(k)

A retirement savings plan offered through an employer. Money comes straight from your paycheck, often with an employer match.

Work it out

Ava earns $40,000 a year. She compares Social Security and Medicare tax as an employee on a W-2 with the same $40,000 as a self-employed worker on 1099s.

1. Yearly earnings
2. W-2: Social Security, 6.2%
3. W-2: Medicare, 1.45%
4. W-2 payroll tax
5. 1099: Social Security, 12.4% of $36,940
6. 1099: Medicare, 2.9% of $36,940
7. Self-employment tax
8. W-2 payroll tax
9. Extra for the 1099 worker

Check yourself

1. You earn $1,000 as an employee. How much Social Security and Medicare tax comes out of it?

   • A. $62.00
   • B. $76.50
   • C. $153.00
   • D. $14.50

2. What does your tax return do?

   • A. Asks your employer for a raise
   • B. Works out your true income tax for the year and settles it against what was withheld
   • C. Sets your sales tax rate
   • D. Opens a Social Security account

3. Who pays both halves of Social Security and Medicare tax?

   • A. An employee on a W-2
   • B. A retiree
   • C. A self-employed worker paid on 1099s
   • D. A student with no income

Your turn

Pull up your latest pay stub and find four lines: federal income tax, state income tax, Social Security and Medicare. Check that Social Security is 6.2% and Medicare is 1.45% of your gross pay.