Payroll deductions are withheld from an employee's gross earnings for income taxes, benefit payments, or other permissible reasons. Some payroll deductions are mandatory while other payroll deductions may be voluntary.
What Is a Payroll Deduction?
Payroll deductions are amounts withheld from an employee's paycheck to account for certain designated expenses, such as taxes or benefits plans, and savings initiatives, such as retirement plans. Payroll taxes, for example, are deducted from the gross amount of pay an employee has earned before they receive their paycheck for a given pay period. Employers are obligated to remit or deposit these withheld amounts to the appropriate agencies and designees.
Other common payroll deductions that may be taken from an employee's paycheck include benefits premiums to cover the employee's portion of any medical insurance or other insurance electives, union dues, retirement savings plans, or other optional deductions such as charitable donations. Payroll deductions can be a significant part of processing an employee's paycheck, but they are also a necessary step for business owners to help employees meet their obligations, such as child support payments.
How Do Payroll Deductions Work?
Employers receive information about an employee's deductions from different sources that are a part of the payroll process. Payroll taxes are typically based on the employee's W-4, a required form that assists payroll departments when calculating tax withholdings for an individual. Benefit elections might come from authorization forms filled out by an employee, or selections made through an online portal. Payroll departments may also receive court orders directing them to withhold a set amount of employee's wages for garnishments.
The payroll department should set up a standard procedure for gathering payroll deduction information. Employers with staff in multiple geographic locations may need to adjust their payroll process to withhold for a number of different state and local tax rates. As complexity increases, a small business may need a more sophisticated payroll system or consider outsourcing their payroll to a trusted provider.
Types of Payroll Deductions
Some typical payroll deductions may be mandatory for every employee, while others require employee written authorization. Payroll departments must remove some amounts from gross pay prior to calculating payroll taxes, known as pre-tax deductions. Some types of payroll deductions fit into more than one category — for example, health care can be both voluntary and pre-tax. Each deduction should be reviewed to ensure it’s properly handled throughout the payroll process.
Mandatory Payroll Deductions
Some deductions will be calculated and withheld from employee paychecks without a need for an individual's authorization. Mandatory payroll deductions typically include all payroll taxes. Employers are obligated to withhold these amounts and may face fines or penalties if they fail to do so. Examples of mandatory payroll deductions include:
- FICA: In compliance with the Federal Insurance Contributions Act (FICA), employers must deduct funds from paychecks for the employee's share of Medical and Social Security payments. Employers also pay a portion of FICA taxes.
- Federal income tax: Employees complete a Form W-4 to determine the amount of federal income taxes that must be withheld from their paychecks.
- State and local income tax: In some states and cities, employers must withhold funds to cover the employee's anticipated state and local tax liability.
- Wage garnishments: Employers may be required to hold funds from an employee's paycheck under a court order or at the direction of the IRS for the purposes of recovering unpaid debts, child support, or taxes.
Other mandatory deductions include funds for state-specific requirements such as a state unemployment tax or a state-funded disability program.
Voluntary Payroll Deductions
Employers may also permit employees to request a deduction from their gross pay to cover certain payments or expenses associated with voluntary items, such as benefit plans. Depending on the type of deduction, it may take effect on a pre-tax or after-tax basis. Employees should provide authorization for benefit deductions as part of the annual enrollment process. Examples of voluntary payroll deductions include:
- Health insurance: The employee's share of healthcare premiums may be deducted on a pre-tax basis if employees enroll in a company-sponsored plan. Employees may also contribute to a health savings account or a flexible spending account on a pre-tax basis.
- Retirement plans: Employee contributions to retirement plans, such as a 401(k), may be deducted from their paycheck voluntarily.
- Life insurance and disability plans: This includes premiums or contributions made by the employee toward group life plans, or coverage for short- and long-term disability.
- Other voluntary payments: Other voluntary deductions may include charitable giving, or funds deducted for wellness programs, like a discounted gym membership. - where permissible under state law.
Pre-Tax Payroll Deductions
Pre-tax deductions are applied to an employee's paycheck before any taxes are calculated and withheld. Pre-tax deductions reduce the amount of taxable income, thus reducing the amount of taxes owed by the employee. Common examples of pre-tax deductions include 401(k) contributions, healthcare and dental insurance premiums, health savings account (HSA), or dependent care flexible spending account (DCFSA) contributions. As a business owner or HR manager, it is important to know which deductions are applied before taxes are calculated so that you do not inadvertently overcharge or undercharge your employees when it comes to tax obligations.
After-Tax Payroll Deductions
Some amounts deducted from an employee's paycheck occur on an after-tax basis. The payroll department will withhold all applicable pre-tax deductions, such as payroll taxes, before using the earnings amount remaining to cover these after-tax payments.
After-tax payroll deductions may include the following items:
- Some life insurance or disability insurance payments
- Wage garnishments
- Charitable giving
- Union dues
Get Help With Your Payroll Process
Understanding different types of payroll deductions will help you build an accurate, efficient payroll process that complies with the requirements in your jurisdiction(s). As your company grows and the payroll process increases in complexity, you may want to consider using professional payroll services. Allowing payroll experts to process paychecks on your behalf can give you peace of mind and allow you to focus on what you do best — running your business.
