Tuesday, March 6, 2012

Taxes and Net Income: The Real Numbers Story

I left off yesterday with the encouragement to approach residency like medical school. Depending on whether you took out Student Loans to the maximum, minimum, or some where in the middle, will determine how you view your first paycheck.

Your first check will be much smaller than you anticipated depending on when in the payroll cycle you actually start working. Even though we started our first day on July 1st, our first check wasn't issued until July 13 and it was only for the time period July 1 - July 8. Small. Because it was so small, it didn't have federal income taxes on it. And because it was the first, it didn't have our health care premiums withheld.

The next paycheck was on July 27, but it still wasn't the "real paycheck" because it was still too small to have any federal income taxes withheld, but this check they took out the current health care premiums for that pay period, plus the pro-rated amount from the previous check. Obviously we weren't completely enrolled until then.

Our first real paycheck with all the appropriate with holdings wasn't until August 10th. This would be the paycheck we needed to use to base our budgets on going forward. Take away message: just because you start working on July 1st, doesn't mean you actually start getting paid on that day.

The example I provide here is our actual paycheck from intern year (2006). Don't discount the date saying that salaries have increased so much. I'll explain why in tomorrows post. Also note that this isn't our actual first check.  This was our third payroll check as an intern that included all of our health insurance premiums, taxes, etc.

Your check is obviously going to look different, and the numbers are going to be different. The point is to demonstrate the often dramatic difference between gross and net pay. 

Gross pay = $1,654 per pay period      $43,000 per year
Net pay = $1,349 per pay period          $35,086 per year  

A difference of $7,936 is a big deal. When you hear the gross salary that you are being offered as an intern/resident it is tempting to think you will actually have all that money to use - you don't. You'll have about 20-30% less. 

The reason I say that your actual numbers may be different is because each intern completes a tax withholding form (W4) during their orientation. This document tells the payroll department how much of your check to withhold and send to the federal and state income tax authorities. 

There is a worksheet attached to the W4 form that will assist you in calculating your exemptions which in turns determines your % of withholding. They even have a box that allows you to select an additional amount to include.

Based on our calculations, and our estimated taxes for that year, we selected 9 federal exemptions and 3 state exemptions. We have kept our federal exemptions the same for the last 6 years. Why did we select 9? We knew based on our tax estimates for the year that we would be getting a refund. Why wait until April 15th to get your money when you could have it every month when you could use it. 

This strategy worked for our family (married with children). It may not for yours. The end result is that our federal tax returns were smaller, but during the year we had more money in our paycheck. Your calculations and amounts may be different. They may be smaller, they may be larger. 

Don't be surprised when your payroll checks don't look as large as you thought they would.

Next: The First Year is the Roughest... Not always.

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