The federal and many state governments require employees in the United States to pay taxes via the withholding process. This means that your employer takes the mandated taxes out of your paychecks before you are actually paid. If you are paid on a salary basis, then like an hourly employee, your compensation is subject to taxation. The amount of your yearly salary that is taxed depends on the type of tax.
Only a portion of your annual salary is subject to taxation. To arrive at annual taxable salary, deduct all of your nontaxable benefits for the year, such as Section 125 medical and dental premiums and mileage reimbursement, as well as pre-tax contributions to a 401(k) plan, from your gross annual salary. Otherwise, all other types of earnings that you receive in addition to your salary, such as vacation pay, commission, severance and bonus, are taxable.
Federal Income Tax
Unless you meet the qualifications for exempt as stated on Form W-4, your employer is supposed to withhold federal income tax from all of your paychecks. All of the taxable salary that you make in a given year is subject to federal income tax withholding. Your employer uses IRS Circular E to determine your withholding amount. The Circular E has two withholding methods: wage bracket and percentage. The former tells your employer the amount to withhold from your salary based on your filing status, number of allowances, salary and pay period; it also has a limit on the amount of salary that can be computed using this method. If your salary exceeds the wage bracket limit, your employer can use the percentage method to figure out your withholding amount. This method is also useful for calculating annual tax due instead of pay period tax due.
The Federal Insurance Contributions Act mandates the collection of both Medicare and Social Security taxes, also called FICA taxes. Only up to a certain amount of your annual taxable salary is subject to Social Security tax, but Medicare tax must be withheld from all of your annual taxable salary. Specifically, as of May 2012, your employer withholds Social Security tax from your salary at 4.2 percent up to the annual limit of $110,100; when you earn this amount for the year, the withholding stops and resumes at the start of the next year. Medicare tax has no annual limit.
State Income Tax
State income tax laws vary by state. When required, all of your annual taxable salary is subject to state income tax, unless you qualify as exempt under state law. While some states require employers to withhold state income tax based on rules that are similar to federal income tax withholding, others have entirely different regulations. For example, in Georgia, employers use the state’s Employer’s Tax Guide wage bracket or percentage method to figure out state income tax withholding. But in Pennsylvania, employers are required to withhold from all taxable salaries at a flat 3.07 percent as of May 2012.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.