392 Chapter 9 Taxes
After the year has passed, each taxpayer files a tax return with the appropriate tax agencies,
listing income, deductions, etc. and calculating the total tax owed based on this income. If the
amount withheld and/or paid in estimated taxes is more than the actual amount owed, the tax-
payer receives a refund of the difference. If the amount withheld or paid in estimated taxes is
less than the amount owed, the taxpayer must pay the difference, and may be charged penalties
and interest for the underpayment.^6Example 9.2.7 Suppose that Erik’s actual income taxes for the year are $4,795.16.
Determine the amount he would owe or would receive as a refund after he fi les his
taxes if he had taxes withheld for the entire year at (a) the rate calculated in Example
9.2.5 and (b) the rate calculated in Example 9.2.6.(a) In Example 9.2.5 we calculated Erik’s withholding to be $98.30 for each of his 26
paychecks, and so his total withholding for the year would be 26($98.30) $2,555.80. This
is less than his taxes, so he must pay the $4,795.16 $2,555.80 $2,239.36. He may
also have to pay penalties and interest as well.(b) In Example 9.2.6 we calculated Erik’s withholding to be $230.32 for each paycheck,
so his total withholding would be 26($230.32) $5,988.32. This is more than he owes, so
he will receive a $5,988.32 $4,795.16 $1,193.16 refund.FICA
Income tax withholding is not the only tax collection for which an employer is responsible.
The taxes that fund the U.S. Social Security system and Medicare are also collected by
withholding from an employee’s paycheck. The law that requires these payments is known
as the Federal Insurance Contributions Act, and hence these taxes are commonly referred
to by the acronym FICA.
For 2006, the Social Security portion of the FICA tax was 6.2% up to $94,200 of gross
wages. This percent is paid by both the employee and the employer, so in actuality this
totals 12.4%. The Medicare portion of FICA was 1.45%, also paid by both employer and
employee, though without any upper limit.Example 9.2.8 Suppose that Lesley has a gross (i.e., before deductions) salary
of $43,500 per year and is paid biweekly. She pays $150 with each paycheck for
deductions for health insurance or other benefi ts. How much will be deducted from
her biweekly paycheck for FICA?Lesley’s gross biweekly pay is $43,500/26 $1,673.08. Subtracting out her deductions
leaves $1,673.08 $150 $1,523.08. The Social Security tax will be (6.2%)($1,523.08)
$94.43. The Medicare tax is (1.45%)($1,523.08) $22.08. So her total FICA deduction
will be $94.43 $22.08 $116.51. Note that her employer will also pay an equal amount
of tax.One of the objections to the FICA tax is that unlike the progressive income tax rates, the
Social Security tax is actually in some ways regressive: higher incomes pay a lower rate (as
a percent of total income). The following example will illustrate this objection.Example 9.2.9 Ramon has a gross annual salary of $148,900. Calculate his total
annual FICA taxes.The Social Security tax applies only to the fi rst $94,200 of income: (6.2%)($94,200)
$5,840.40. The Medicare tax does not have an upper limit, so it amounts to (1.45%)
($148,900) $2,159.05. The total FICA tax is thus $5,840.40 $2,159.05 $7,999.45.
Once again, this amount will need to be matched by his employer.(^6) Penalties do not apply in every situation; there are a number of rules that exempt you from paying a penalty,
particularly if the amount owed is small or due to a special situation. However, whenever the amount of tax withheld
is less than the amount owed, there is at least the possibility of penalties being imposed.