How allowances affect your paycheck
The number of allowances you enter on Form W-4 can have a big impact on the pay you take home—and on your taxes. Take a closer look at an example to see how the choices you make influence your overall financial picture.
So I'll just dig a little bit deeper and explore how your paycheck is actually affected in terms of the numbers, depending on how many allowances you pick, and for the sake of this video, I will stick with the single individual making $40,000 a year. Obviously circumstances would be different, you'd have a different number of allowances, if you have someone who's married, filing jointly, or they have more dependents than what we're talking about in this video.
And what we're going to look at is what will the paycheck look like and what will the withholdings look like if the person elects to have one allowance, so they only put this 1 right over here in line A, or if they want to have two allowances because they could put a 1 right over here because they are single and they have only one job, or we're assuming they have only one job. So let's go into the numbers a little bit.
So we're assuming that we start off with, at least from this employer, gross income that the employer knows about, so the income is $40,000. And actually, let me do two cases here. So this right over here would be the case of 1 allowance, and over here the case, I'm going to have 2 allowances. So once again, the 2 allowances won't change what the actual gross income is, so it's $40,000.
And regardless of how many allowances are filled out on the W-4 form, you're going to pay the same amount in Medicare and Social Security tax, so let me fill that out. So Medicare, which is going to be 1.45% of this income, is going to be – let me get my calculator out – so let's see, 40,000 times 1.45% is the same thing as 0.0145 is going to be $580. So I'm going to pay $580, so minus $580. I'm going to do that in either case. That's not dependent on the allowances.
And now let's calculate Social Security, so Social Security tax, this is going to be 6.2%, and these are all the rates at the time of making this video. If you watch this video at a different year, I encourage you to look up the rates that are relevant in that year. So 6.2%, once again you're going to pay on the $40,000, get the calculator out again. So $40,000 times 0.062, that's the same thing as 6.2%, that gets us to $2,480, so minus $2,480, minus $2,480.
And now let's calculate what the federal income tax is, and so in order to figure out federal income tax, so far these are things that you're paying regardless of what the allowances are but now the allowances are going to start to factor in when you think about your federal income tax. So let's do taxable income.
Actually let's do it this way, so we're going to start with our gross income. Now, this person I going to get the standard deduction, and for a single person in the year that I'm making this video, the standard deduction is $6,200, so let me write it over here. Let me do it in a new color. So standard deduction, and the things I'm going to list now, the standard deductions and the amount you get for your allowances, these are things that are going to lower you taxable income.
So your standard deduction is $6,200 – that's true regardless of how many allowances you pick – and then allowances. This is going to be the key difference, allowances, and so you're going to lower your income, at least in the year that I'm making this video, by $3,950 per allowance, so if you have one allowance, you're going to reduce your income by $3,950. If you have two allowances, it's going to be two times that, so it's two times $3,950, so let's see, two times $4,000 would be $8,000, and it's going to be $100 less than that so it's going to be $7,900. Did I do that right? Yeah, that's $7,900. Excuse me, I had something in my throat. So let's see, $7,900. It still feels like it's in my throat but I will power on.
So once again, these are your allowances, and so now based on this, then once again, this is all your employers. This isn't us doing our taxes. This is our employer estimating how much taxes we'll have to pay, but your employer doesn't know about other things going on in your life, donations that you might be making to charity or income that you might be getting from other sources, from investments or whatever else. This is just what the employer knows based on how much it's paying you and what you filled out in the W-4 form.
And so based on the gross income up here and the standard deduction and the allowances, we can then come up with your employer's estimate of your taxable income, so taxable income. In this situation, and if you only have one allowance, it's going to be your gross income, $40,000, minus the standard deduction, $6,200, minus $3,950 gets us to $29,850.
Now if you have 2 allowances, it's going to be, well, you could say we're going to subtract another $39,450. You take $40,000 minus $6,200 minus $7,900, let me just do that. So it's $40,000 minus the standard deduction – once again, we're adjusting our gross income to taxable income – minus two times this, so $7,900 for two allowances. Now if you had three or four or five allowances, then you would be subtracting that multiple of $3,950 here. And so you're $25,900.
And so now we can figure out how much tax this person's going to pay. And we've already done videos, and I encourage you to watch those videos on the Progressive Tax System, where the first X dollars you pay a lower rate, and then you have incremental brackets, and for those incremental dollars you pay higher and higher rates. And at the time of making this video, the first $10,000 you're going to pay 10%, so let me just write the taxes right over here. I'm only going to calculate federal income taxes. State income taxes vary, but your employer also typically withholds for state income tax as well.
The federal taxes, it's going to be 10% on the first $9,075, and then it's going to be 15% on the amounts to this. The bracket goes into $36,000 and some change but we're below that, obviously, and so it's going to be $10,000 on the first and then 15% up to the figures given here because they are in the 15% tax bracket. That bracket, as I said – actually let me look it up. I'm going to pause the video and I'll look it up. So I just looked it up. Right now it's 15% up to $36,900, so let me write that. $36,900, and clearly these are within that range. So based on that, let's actually calculate what the Federal taxes are going to be for each of these scenarios.
So in the first scenario with one allowance, you're going to pay 10%, so 0.1 times the first $9,075. That's actually pretty easy to calculate, it's going to be $907.50 but I'll just write that. Times 9075, and then you're going to pay 15%, 0.15, on the next increment, times this amount, $29,850, minus 9075. Remember, it's only of the incremental amount. Minus 9075 gets us to $4,023.75. $4023.75, so that's the estimated Federal taxes that your employer is estimating in this scenario.
And then in this scenario it's going to be, get it back, and essentially I can do the same exact. Let me just do that same thing that I just typed in but instead of the $29,850 it's now $25,900. It's lower now because I now have 2 allowances instead of 1. And it is going to be, it gets us to $3,431.25. $3,431.25.
So this is going to be your employers' or the person's employer's estimate of what they get, so net to employee, and I should say estimate. Or this is actually what's going to be paid to net to the employee but it's based on an estimate of likely taxes. Net to employee is going to be, so let's get all of our information out here, it's going to be the $40,000 that's your gross income, and I'm doing the case first with one allowance, minus the $580 in Medicare taxes minus the $2,480 in Social Security taxes. – And this is what you're going to pay regardless of how many allowances, so let me start with that.
So $36,940, so that's after paying Medicare and Social Security taxes, and then if you have 1 allowance, you're going to have the Federal income taxes of $4,023.75, so that's minus $4,023.75 gets us $32,916.25, so let me write that down. That is $32,916.25. So once again, this is your employer's estimate of what you should be getting after you pay your taxes. Once again, your employer does not know about other sources of income, investments that you might have or donations to charity or whatever else. And so on a biweekly basis, if they pay you every two weeks, since there are 52 weeks in a year, they'll pay you 26 times a year, they'll pay you 1/26ths of this, and we'll actually calculate that in a second.
But before we do that, let's actually calculate the situation where you have two allowances. We already saw that after paying for Medicare and Social Security, you had $36,940, so let's do that again. $36,940, and then now subtract your lower taxes, because you had two allowances so you had estimated lower taxable income, so $3,431.25 – $33,508.75. So this is $33,508.75.
And so on a per paycheck basis – and remember, the whole point of this is to see how your allowances affect your actual paycheck. Let's get the calculator back. So the second one, if we divide by 26, so assuming you have 26 pay periods in a year, each paycheck you're going to get $1,288.80, so that's going to be your biweekly paycheck. So let me write this, paycheck, so we're assuming every other week, so 26 per year, and in the one allowance circumstance, it's going to be $32,916.25 divided by 26 gets us $1,266, unless we round it up a penny, so $1,266.01. Did I do that right? $1,266.01, if we were to round.
So roughly speaking, that extra allowance for this individual right over here has resulted, when they put the extra allowance, they get a little bit over $20 more per paycheck which amounts to a little more than $40 per month, and of course it's not just free money. If at the end of the year, if they ended up paying this much in taxes, but it turns out that they actually should have paid this much in taxes, then come before the tax deadline, they're going to have to pay the IRS the difference.
Now on the other hand, if they pay this much, if this much is withhold but they didn't have to pay that much, they're going to get a refund, and really that's up to that person to decide how conservative or aggressive they want to be on that issue.
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