One of the greatest draws to many jobs is the money you earn for it (obviously). Depending on where you work, your pay can be accrued on an hourly or salaried basis. In many sales-related cases, you might get paid via commission instead. No matter which basis you’re paid out on, it’s important when budgeting and planning your financial goals to calculate how much money you will earn on a yearly basis. That number is not the same as the number you earn on paper. In many cases, it can be quite different.
Your gross income is the total amount of money that is paid to you, no matter its source. If you earn $25 per hour and work 40-hour weeks for 50 total weeks over the course of the year, your gross income would be $50,000 for that year. If you get paid $30 per hour and work the same schedule, it would be $60,000. Great! That means you can now budget for $5,000 every month, right?
Nope, you’ll set yourself up for disappointment if you think of your pay in terms of gross income. Your net income is the amount you should be concerned with in practical terms. That is the money that gets received by you directly after all of your deductions are withdrawn from the pay period.
There are many different types of deductions you can expect to pay depending on your situation. As Benjamin Franklin once famously observed, life guarantees us only “death and taxes.” Taxes are the most common deduction you will see on your pay statements. The rate at which you are taxed depends on factors such as how much you’re expected to earn and where you live.
Federal Income Tax
The federal income tax is usually the largest sum you pay. It is the money you owe to the IRS to fund the federal government of the US. This type of tax is called a progressive tax, meaning that as your total income increases, so does the percentage of that income you owe. The current 2023 rates and brackets are as follows:
| Tax Rate | Taxable Income (Single) | Taxable Income (Married Filing Jointly) |
| 10% | Up to $11,000 | Up to $22,000 |
| 12% | $11,001 to $44,725 | $22,201 to $89,450 |
| 22% | $44,726 to $95,375 | $89,451 to $190,750 |
| 24% | $95,376 to $182,100 | $190,751 to $364,200 |
| 32% | $182,101 to $231,250 | $364,201 to $462,500 |
| 35% | $231,251 to $578,125 | $462,501 to $693,750 |
| 37% | Over $578,125 | Over $693,750 |
Doing the Math
What’s important to recognize when looking at this table is that your income is taxed on a marginal basis as it accrues. Above, we referenced someone earning a gross income of $60,000 per year. If he paid a flat rate of 22% on all $60,000 of that income, he would owe $13,200 just in federal income taxes alone. Fortunately, the hit to your wallet isn’t as brutal as it looks at first.
In this filer’s case, the first $11,000 is taxed at the 10% rate ($1,100). Then, the next $33,724 he earns is taxed at the 12% rate ($4,046.88). The remaining $15,276 that he earns is taxed at the 22% rate ($3,360.72). Thus, his total federal income tax burden would be $8,507.60. That’s more than a $4,000 difference between what it originally appeared to be. When it comes time to file in April the following year, the total burden may end up being quite different, as there are numerous deductions, exemptions, and other related factors that can affect the total amount owed.
Other Taxes
Your state’s personal income tax is the money you owe to the state in which you reside. There are seven states that have no personal income tax: Wyoming, Washington, Texas, South Dakota, Nevada, Florida, Alaska. Much like the federal government, many state governments utilize a progressive tax system as well, though with different brackets. There are four progressive income tax states that have personal income tax rates that reach above 10% for their highest earners: California (13.3%), Hawaii (11%), New York (10.9%), New Jersey (10.75%). Washington, D.C. also has an income tax rate of 10.75%. The other states will fall in between. I live in Pennsylvania, which has a flat personal tax rate of 3.07%. A flat tax means the rate is not affected by how much income you accrue. As with the federal income tax, the amount you end up owing will be affected by the deductions, exemptions and credits applicable to you. Read more about the way taxes are collected in your state to understand your position better.
Another tax you pay to the federal government that is separate from the federal income tax is the FICA tax. The Federal Insurance Contribution Act stipulates the amount of money owed by employer and employee to programs that it funds, primarily Social Security and Medicare. If you are on a company payroll, the tax burden will be split between you and your employer. You pay a rate of 7.65%, same as them. If you earn $60,000 per year, that total amount owed is $4,590. If you are self-employed, that number is doubled to $9,180 because you pay both the employer and employee portions in that case.
Depending on where you live, you might pay additional taxes to your city or local government. You might also have additional deductions from a debt that is being garnished from your wages or a premium you pay for insurance. Finally, the one deduction that benefits you directly in a way the others don’t is a retirement account contribution. We will discuss retirement savings in a later post, but needless to say, you should make it a priority to set aside at least some money from every paycheck you receive as soon as you’re able to.
Your Net Pay
Once you’ve gone through all of the deductions, you can finally calculate your net pay. Let’s say you earn an annual salary of $60,000 and you live in the state of Pennsylvania like me. Here is what you can expect to pay in deductions:
- Federal income tax: $8,507.62
- FICA tax: $4,590
- State tax: $1,842
If you have no other deductions, your total tax burden for the year should be approximately $14,939.62. In practical terms, you will only get to utilize about $45,000 of the money that you earned. That gap makes a massive difference. Always keep that in mind when searching for a new job and consider all of the relevant factors that will affect how much money you owe, many of which were not discussed here at all. When you sit down and calculate how much money you will actually keep, you will be much more prepared to make financial decisions than if you start with the number you earn on paper.
Finally, keep in mind that the tax system in the United States is much more complex than can be explained in an 1,100 word post. The numbers in this article are all as of the past tax year, but don’t expect your situation to mirror the relatively simple scenario I laid out here. When it comes time for you to do your own taxes, do as much research as you can to best understand your situation. My hope is that this post conveyed enough information to paint a broad picture as to why gross and net incomes can often be so vastly different.
Best of luck to you all. Peace!
