Types

• The federal taxes that may be withheld from a paycheck include income taxes and payroll taxes, also known as FICA taxes. The FICA tax is made up of the Social Security tax and the Medicare tax. Only the Social Security tax has a limit on the amount of income it applies to, which adjusts annually for inflation. In 2010, the limit is set at the first $106,800 that an employee earns. As of 2010, the Social Security tax rate is 6.2 percent and the Medicare tax rate is 1.45 percent.
  
  

History

• The Federal Insurance Contributions Act, passed in 1935, required money to be withheld from paychecks for Social Security taxes and Medicare taxes. The Current Tax Payment Act of 1943 forced taxpayers to have money withheld from their paychecks for their income taxes. Instead of making one large payment at the end of the year, taxes would be taken out as the money was earned.
  
  

W-4 Forms

• When you start working for your employer, you must complete a W-4 form that shows your employer how many personal allowances you are claiming and whether the employer should withhold money at the single or married tax rate (for income tax withholding). Personal allowances reduce the amount of income subject to income tax withholding by an amount that adjusts each year. As of 2010, each allowance claimed reduces the income subject to withholding by $3,650. Personal allowances do not affect the amount of FICA taxes withheld.
  
  

Time Frame

• Each time you are paid, the amount that you have withheld assumes that you will make the same amount for every pay period during the year. For example, if you make $5,000 in a month, the withholding tables assume that you would make $5,000 every month so that your annual income would be $60,000 even if you only worked one month out of the year. Your personal allowances are also split up over the number of pay periods you are expected to have during the year. For example, if you are paid monthly, in 2010 your income subject to income tax withholding is reduced by $304.17 per allowance claimed.
  
  

Size

• The percentage withheld for income taxes depends on the amount you make. The United States uses a progressive income tax so the higher your income, the higher the withholding percentage. For example, for 2010 if you are single and paid monthly, the income between $504 and $869 has income taxes withheld at the 10 percent rate while income between $5,642 and $7,038 has income taxes withheld at the 27 percent rate.
  
  

Effects

• When you complete your tax return and determine how much tax you owe, you can subtract the amount you have paid in income tax withholding during the year from your total income tax bill. If your income tax withholding exceeds your tax liability, you will receive a refund from the government of the extra you paid. However, if your income tax withholding falls short of your tax bill, you must pay the extra and, depending on how much you are short, you may have to pay additional interest and penalties.