Accounting and Finance Foundations

Unit 8

Accounting and Finance Foundations Unit 8: Payroll 656

Payroll

Chapter 19

Student Guide

Net PayLesson 19.2

Everyone who has ever worked will tell you there are many deductions from your gross pay, including

federal, state, local, Social Security, and Medicare taxes. By law, employers are responsible for withholding

and paying Social Security, Medicare, and federal and state income taxes for their employees. The amount

of an employee’s gross pay minus deductions is net pay.

One of the largest deductions from an employee’s paycheck is income tax. The tax paid to the federal

government is called federal tax withholding, while the tax paid to the state government is state income tax.

The tax withheld is based on three things: the employee’s gross earnings, the employee’s filing status, and

the number of withholding allowances the person claims. A withholding allowance, also called an exemp-

tion, is a portion of gross earnings that is not subject to tax. Each employee is permitted one withholding

allowance for himself/herself, one for a spouse, and one for each dependent (a child or elderly parent).

In order for an employer to know how many exemptions an employee wants to claim, all employees must

fill out a federal W-4 form when they are hired. Employees indicate their marital status and filing status on

this form. To see and/or complete an actual W-4 form, go to http://www.irs.gov/pub/irs-pdf/fw4.pdf.

An employee’s completed W-4, along with her/his employer’s pay schedule (weekly, semi-monthly, etc.),

are used to figure the amount of federal income taxes withheld from the employee’s pay. The amount of

taxes withheld can be found using wage bracket tables provided by the Internal Revenue Service (IRS). All

of the IRS’s wage bracket tables for income tax withholding are available on pages 38-57 of Publication 15

(Circular E), Employer’s Tax Guide, found at http://www.irs.gov/pub/irs-pdf/p15.pdf.

Let’s continue using Wes as an example. Remember that in a prior example, Wes’s gross pay was $267.

When he filled out his W-4, he claimed only himself, and he declared himself single (S:1). How do you now

determine Wes’s net pay?

Remember, net pay is an employee’s gross pay minus deductions. If Wes’s only deduction is federal tax,

then to determine his net pay, we just need to determine his federal taxes. And, to determine the federal tax

that should be withheld, Wes’s employer should use an IRS wage bracket table.