Todd Erkis is a visiting professor of finance at St. Joe’s who writes weekly columns answering students’ financial questions.

This column is a continuation of last week’s question about what a college student should know about taxes, asked by Julia O. ’22, economics major

Last week, we discussed how to fill out a Form W-4 when you start a job and how to file your federal taxes that are due by April 15 each year. This column is going to talk about the taxes you pay to the federal government. 

One of the shocking things when receiving a paycheck is the size of all of the deductions that decrease the amount you end up getting. Many of the largest deductions are for taxes. These include the federal income tax withholding that we discussed last week, Federal Insurance Contributions Act (FICA) Medicare and FICA Social Security. The last two are taxes to pay for Medicare, a federal program to provide health benefits to people with low incomes, and for Social Security, a federal program that provides income after retirement and in other certain circumstances. The money collected for these FICA taxes is paid and that’s all.

You file the Form 1040 to compute the amount of the tax you owe or if you will receive a “refund.” In the Form 1040, you summarize all of your income and other earnings, like interest earned on bank balances. This number is called your “adjusted gross income.” The adjusted gross income is decreased by various deductions to arrive at your taxable income. Many people will simply take the standard deduction, which is $12,400 for a single person. This means that if your total income is less than $12,400, you have no taxable income and will not pay any federal income tax. 

The way federal taxes are collected is often misunderstood. Some say it’s good to get a refund after filing your federal taxes. The logic is that most people have spent most of their paycheck and the refund is a good way to save money during the year. Some people even try to get a refund each year. However, it’s important to understand that the government is just giving back the money it took from you during the year. In other words, the withholding was too high (they withheld more than you owe) and you could have used that money during the year to buy something or to invest it. Also, the government does not pay you interest on that money, so you are essentially giving the government an interest-free loan.

But trying to withhold as little as possible has drawbacks too. First, if you owe more than what was withheld, you will need to come up with the money when you file your taxes. This can be a large amount and some people may not have the money available to pay, which is a big problem. The IRS has payment plans, but they will charge you interest on the amount owed. We don’t ever want to get into this situation. Also, the IRS will charge you a penalty if you need to pay more than a specific amount relative to what you owe in total. Both of these reasons are why it’s important to correctly fill out that Form W-4 we talked about last week.