Why your paycheck is smaller than your wages

Most people look at their paycheck and wonder why the amount they take home is so much smaller than what they earned. Understanding deductions is basic financial literacy, and it helps you plan for rent, utilities, food, transportation and debt payments. Every paycheck includes required deductions for taxes and federal programs, and many workers also have optional deductions for benefits or insurance. When money is tight, knowing where each dollar goes can help you ask the right questions at work, avoid surprises and plan a more stable household budget.

Your paycheck shows both gross income and net income. Gross income is what you earned before anything is taken out. Net income is what you actually receive in your bank account or on a paper check. Everything between those two amounts is a deduction. Some are required by law. Some are voluntary. Some reduce taxes and others do not. The sections below explain each major type in clear terms. Also, if when it comes time to file taxes, if you want someone to help you navigate the system look into the free Volunteer Income Tax Assistance (VITA) Program.

Federal, state, and local government income taxes withheld

Taxes are the most common deduction from every paycheck, however the good news is that if your income is low enough some of that money may be returned to you when you file a return. Federal income tax is withheld based on the information you entered on your Form W-4 and the tax tables from the Internal Revenue Service.

The amount taken out may not match your final tax bill for the year because your total income, tax credits, dependents and other deductions affect your true tax obligation. Some people withhold too much and some withhold too little on their weekly paycheck. If too much is taken out, you receive a refund. If too little is withheld, you may owe money at tax time. Details about federal tax withholding are at https://www.irs.gov/taxtopics/tc753.

paycheck deductions

Most workers also pay state income tax except residents of Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee do not tax wages but do tax certain investment income. If you live in a place with city or local income taxes, such as New York City, Philadelphia or many municipalities in Ohio and Pennsylvania, your employer is required to withhold those as well.

  • State tax rules differ, but the basic idea is the same. Your employer withholds money based on state forms and instructions. If your income is very low, you may have little or no state tax withheld. If your earnings rise or if you worked multiple jobs during the year, you may find the withholding was not enough.

Social Security and Medicare (FICA) taxes

All workers pay Social Security and Medicare taxes under the Federal Insurance Contributions Act. These programs provide monthly income for seniors, disability benefits and national health insurance for older adults, including funding programs such as SSI.

The Social Security portion is 6.2 percent of your wages up to the annual limit set by the federal government. Medicare is 1.45 percent of all wages with no income cap (This is for health care insurance for the disabled as well as seniors). Together, these deductions reduce take-home pay for every wage earner, even for people who are struggling financially.

Additional pre-tax deductions for health insurance, commuting and retirement

There are many other possible deductions from your paycheck. While not everyone has them, it is important to understand them when it comes to managing your finances / budget. Many workers have deductions that reduce taxable income before federal and state taxes are calculated. Pre-tax deductions are important because they lower the amount of income that taxes are applied to, which can help low-income workers keep more of their paycheck and maybe get a bigger refund from the IRS.

Health insurance premiums through an employer plan are usually deducted pre-tax and can include medical, dental and vision coverage. When a family plan is selected, the deduction can be large and have a major effect on weekly take-home pay.

If your employer offers a retirement plan such as a 401(k), your contributions are normally taken out before taxes. Some plans also allow Roth contributions which are deducted after taxes – so there is no deduction for them. Many companies automatically enroll new employees to help people build savings. The exact rules for retirement contributions are published by the United States Department of Labor at https://www.dol.gov/general/topic/retirement.

Some employers offer commuter benefits in cities with high transportation costs. These allow workers to set aside pre-tax funds for transit passes or parking. These benefits can help workers who depend on buses, rail lines or parking garages to reach their jobs.

Flexible spending accounts for health care or dependent care are also common pre-tax deductions. These allow workers to use pre-tax dollars for medical appointments, prescriptions, child care and other eligible expenses. The employer holds the money and workers submit claims. If you do not use the funds by the deadline set by the employer’s plan, the unused amount may be forfeited. Program rules are outlined at https://www.irs.gov/publications/p969.

After-Tax deductions

After-tax deductions are taken out after taxes are calculated. These do not reduce your tax bill immediately, but some may be deductible when you file an annual return. Examples include employer-offered life insurance beyond the basic coverage provided by the company, extra disability coverage, union dues, charitable contributions arranged through payroll and other elective items. These deductions vary widely by employer and job type.

Some jobs require workers to pay for uniforms, equipment, shoes or tools. Federal rules allow these deductions only if the deduction does not bring the worker’s pay below minimum wage. This can be for a wide range of weekly paycheck type jobs, including nurses, mechanics, cashiers, and mostly serve type jobs.

  • States may have stronger worker-protection laws that forbid some of these deductions or require written consent from the employee. Workers who believe improper deductions were taken can review state rules or contact the United States Department of Labor at https://www.dol.gov/agencies/whd.

Wage garnishments and court-ordered deductions

When a person falls behind on certain debts, courts or government agencies can require an employer to withhold part of the worker’s paycheck. This process is called wage garnishment. The rules depend on the type of debt.

Court judgments for unpaid medical bills, credit card balances or similar debts often follow federal limits. In general, no more than twenty-five percent of disposable earnings can be garnished or the amount above thirty times the federal minimum wage, whichever is less. Details are provided by the United States Department of Labor at https://www.dol.gov/agencies/whd/garnishment.

Child support orders are enforced with automatic wage withholding. If a parent does not make payments voluntarily, federal law requires employers to take out the amount ordered by the court. States administer these programs and may allow or require additional amounts to cover past-due support.

  • Once a child support order is made, an automatic wage withholding order is created as required by the Family Support Act of 1988.Information about national rules is at https://www.acf.hhs.gov/css.

Federal student loans can also be taken directly from wages when a borrower defaults. The United States Department of Education can order employers to withhold up to fifteen percent of disposable pay. This can happen without a court hearing, although borrowers have rights to challenge errors. Information is at https://studentaid.gov/manage-loans/default. Note it is always possible to get help with these loans and other debt(s), and find programs for debt reduction.

Federal and state tax departments (including the IRS) can also garnish wages for unpaid taxes. These agencies follow their own formulas and do not use the standard consumer-debt limits. The Internal Revenue Service explains its process at https://www.irs.gov/businesses/small-businesses-self-employed/wage-levies.

Deductions that cannot be legally taken

Employers cannot deduct money for their own convenience or to cover their own business losses. For example, they cannot charge employees for customer nonpayment, company losses or general business expenses. They also cannot take deductions that violate minimum wage rules or state labor laws. If a deduction on your paystub looks questionable, workers can request an explanation from payroll, review state wage laws or contact free legal aid services for help.

Why understanding take home pay and deductions matter

For people living paycheck to paycheck, even small deductions can create financial stress. Understanding what each deduction means helps you plan your budget and know whether the deduction is optional, required by law or something you can change. Learning the difference between pre-tax and after-tax deductions also helps you understand why certain choices affect take-home pay more than others. If a paycheck seems lower than expected or a number looks unfamiliar, it is reasonable to ask your employer’s payroll or human resources department for a full explanation. Workers have the right to know exactly how their wages are calculated.

By Jon McNamara