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Understand your taxes: Know what you pay and why you pay it

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Few topics in life provoke as much worry and uncertainty as taxes.

For most people, taxes are a sum of money that disappears from every paycheck, and then every year, sometime before April 15, they have to gather information from various sources and prepare a tax return.

Some get lucky and get money back. Others don't withhold enough and have to write a check.

Most people don't give their taxes much more thought beyond the fact that it's money out of their pocket. But it is important to pay attention to all tax deductions and the funding of other programs that are withheld from your paycheck. The time you invest now can greatly reduce tax season uncertainty.

Paycheck deductions

When you receive your next paycheck, or paystub if you use direct deposit, review the info posted on it more closely. Here's a rundown of what you'll typically see.

Federal income taxes

Federal income tax might be abbreviated as Fed Tax, FT or FWT. This amount is credited against any tax you'll owe the federal government when you file your return in the spring. The amount withheld from your pay depends on your filing status (married or single) and number of allowances you claimed on the Form W-4 you filed with your employer when you were hired.

If you're married, you can withhold at the higher single rate. Work with your deductions to get the balance right: Withhold too much and you'll give the government a free loan, but withhold too little and you'll owe a chunk of change in April. Neither is ideal.

State income taxes

If you live in a state with an income tax, that tax may appear on your paystub as St Tax, ST or SWT. Your paycheck might also show the abbreviation of the state for which tax is being withheld (PA tax, for example).

Depending on where you live, you might not have a state income tax, or, if you live in one state and work in another, you might have withholding for more than one state. Just like your federal taxes, the amount withheld depends on your filing status and the number of allowances on the state equivalent of the Form W-4 you filed with your employer when you were hired.

Local income taxes

Some counties or municipalities have an income tax, too. Local income tax might be withheld on wages earned inside city, county and school district boundaries. If you live or work in a jurisdiction that levies a tax, wages will be taxed by that jurisdiction.

Social Security and Medicare

Social Security tax might appear as FICA, SS, SSWT or OASDI. Even if you have $0 withheld for federal, state and local income taxes, you usually must have Social Security and Medicare taxes withheld.

Medicare tax might be abbreviated MWT or Med. This amount is withheld so you´ll be covered by Medicare when you reach age 65.

Other deductions

Your paystub may also show deductions for health or life insurance. If it does, your stub might show whether the premiums were deducted before tax or after tax. Before-tax deductions will reduce the income you pay taxes on to federal, state, and local governments.

'Sheltered' income

Tax shelters are not just the tool of the super-rich. They are available to the average taxpayer, too, and you may see them on your pay stub.

A tax shelter is simply a mechanism that allows you to pay less in taxes than you might ordinarily pay, depending on your tax bracket. Flexible spending accounts (FSAs) and 401(k) or 403(b) or similar retirement accounts are the most common.

FSAs are available through employers for qualified expenses, such as health care, dependent care and transportation to and from work. They allow you to pay qualified expenses in these categories with "pre-tax" dollars. What that means is that the money you spend through an FSA is not taxed. As a result, depending on your tax bracket, you might save 10 percent, 20 percent or more on your bills for day care, medical deductibles or commuting.

Contributions to tax-deferred retirement accounts, such as 401(k)s, are not included in your adjusted gross income, the amount you pay taxes on. Taxes for these accounts, however, are simply deferred. You will pay taxes on withdrawals from these retirement accounts, but you may be retired and earning less money, so you should be taxed at a lower rate. Any growth in your retirement account investments will be tax-free until withdrawal.

Overall, FSAs and tax-deferred retirement plans offer the average taxpayer a good opportunity to save money in the short term and over their lifetimes.

Other taxes and fees

Your paycheck is an obvious place to review some of the taxes you pay.

The American Institute of Certified Public Accountants has a calculator on its website that makes it easy to see many of the other taxes and fees you pay and chart them in relation to your major tax categories. The Total Tax Insights Calculator helps you determine the approximate amount of your tax bill by estimating more than 20 different taxes you may not even be aware you're paying. The calculations may surprise you and may ultimately influence some of your personal financial planning decisions.

A CPA can help

There are many components to understanding your personal tax obligations and how they affect you. A good place to start is by effectively managing your personal withholdings from your paycheck. In addition, it literally pays for you to understand the taxes you pay in your daily life. By themselves, each may not seem to have a great impact, but they all add up.

Visit for great personal financial planning advice and tips for every stage of your life.

For more information about Pennsylvania Institute of Certified Public Accountants (PICPA), visit

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