By M Katie Helle, CPA

With most employers offering direct deposit, people rarely look at their pay stub to understand where the money came from in their bank account.  It’s important to do a quick review to understand where your hard-earned money is going before it gets to you.

Your paycheck typically comprises of gross income, payroll deductions and tax withholding resulting in the net pay which is your take-home pay.

Gross Income

Your gross income consists of the total amount you earned during the pay period.  This is typically described as salary, wages, commissions, bonuses, and tips.  Depending on the benefits your employer offers, you may even see vacation, sick, holiday or other forms of compensation.  It’s important to make sure your employer is paying you correctly based on how you earn income.  For example, if you are paid hourly, you will want to double check the number of hours included in your paycheck to ensure this is correct.  Once you have checked the number of hours, you can multiply this number by your hourly rate to calculate the gross income.

Payroll Deductions

Now that you understand gross income, it’s time to look at your payroll deductions.  There are typically two types of payroll deductions you will see on your check stub: before-tax and after-tax deductions.

These deductions are unique and affect your income differently.

Before-tax deductions are subtracted from your gross income before taxes are taken out.  These deductions will reduce your taxable income, which ultimately means you will pay less tax.  Some examples of before-tax deductions include retirement plan contributions, health and dental insurance premiums, vision plan premiums, and health savings account contributions.  These deductions are typically seen when the employer offers benefits to their employees.

After-tax deductions include things that do not qualify for a before-tax deduction.  These deductions will be subtracted from your paycheck after taxes are taken out.  Some examples of these deductions include retirement plan loan payments, garnishments, and contributions to a Roth retirement plans.

Tax Withholding

There are several different types of tax withheld from your paycheck.  These taxes include federal income tax, Social Security tax, Medicare tax, and state and local income tax.

Federal income tax withholding is determined by several factors including your income for the pay period, your year-to-date income, as well as your Form W-4 Withholding Allowance selection. It’s important to properly complete Form W-4 as this form can have major consequences since it determines your withholding based on the number of allowances.  Too many allowances will result in paying too little tax, whereas too few allowances will result in paying too much tax.

Social Security tax as well as Medicare tax are straight forward tax calculations.  Social Security tax is 6.2% of the first $128,400 in earned income for 2018.  The 2019 wage base is projected to be $132,300.  Medicare tax is 1.45% of all income earned, plus an additional 0.9% for earnings above $200,000 for single filers and $250,000 for married filing joint filers.

The state and local tax withholding vary greatly depending on where you live.  Arizona law requires employers to withhold state income tax.  An employee will complete a Form A-4 Employee’s Arizona Withholding Election to determine the amount of state withholding.

Understanding your pay stub is an important way to ensure you are receiving your hard-earned money, and you are paying the right amount of taxes.  You should review the last pay stub of the year with your Form W-2 to ensure all numbers reported on the W-2 match the last pay stub.  You should also reevaluate your federal and state tax withholdings annually to check that you are having the proper amount withheld.  Your goal should be to break even or have a small federal and state tax refund after filing your taxes.

Now that you know what the numbers on your pay stub are for, you should be able to understand how your employer arrived to the “net pay” or the amount direct deposited into your bank account.