Gross pay includes wages, tips, salary, bonuses and non-cash fringe benefits. Take-home pay, also known as net pay, equals gross pay minus taxes. An employer deducts Social Security tax, Medicare tax and federal taxes from every paycheck and must make his own contributions to Social Security and Medicare on behalf of the employee. In most localities, employers also deduct state and local taxes. An employer may also deduct voluntary withholdings, such as contributions to a retirement plan.
Social Security and Medicare Taxes
An employer must deduct 4.2 percent of an employee's first $106,800 in gross pay for Social Security tax. He must also pay the Social Security Administration 6.2 percent of the employee's first $106,800 in gross wages on behalf of the employee. He must deduct 1.45 percent of the employee's gross wages for Medicare tax, with no income limit, and make an equal contribution on behalf of his employee. Employer contributions are not deducted from the employee's paycheck.
The employer must deduct the employee's estimated federal income taxes from the employee's paycheck. The withholding is only estimated because federal tax rates vary according to a taxpayer's annual income, and the employee's annual income will not be determined until the end of the tax year. If the employer withholds too much, the employee will be entitled to a tax refund. If he withholds too little, the employee must pay the difference.
State and Local Taxes
Forty-one states impose a state income tax. Typically, the state income tax rate is considerably lower than the federal income tax rate. As of March 2011, the states of Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Tennessee, Washington and Wyoming did not impose a state income tax. Some local governments impose an income tax, and some don't. The employer must withhold both state and local income taxes from employee paychecks.
The employer must provide his employee with Form W-2 in time for the employee to use it to calculate his federal and state tax burdens. Form W-2 lists the employee's gross pay, the amount of Social Security and Medicare taxes withheld, the amount of federal income tax withheld, the amount of state and local taxes withheld and any other withholdings. The employer is legally obligated to provide the employee with this document. The employee must submit copies of Form W-2 with his state and federal tax returns, and the employer must submit copies to the Social Security Administration and the state, city or local tax office. Both parties should retain a copy for their records.
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