What are Payroll Deductions
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Written by Stephanie Glanville
Stephanie Glanville is the Marketing Manager of TaxBandits. She has several years of experience with IRS tax forms and the funtionality of TaxBandits. With a passion to help business owners better understand their IRS tax forms and filing, she aims to create content that is valuable and informative.
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Deductions are one of the crucial aspects of the payroll process. Without deductions, no paychecks are generated for the employee. Deductions create a great impact on payroll calculations. Employers must have a clear idea about the deductions and their types to have a smooth payroll process.
Let's explore the payroll deductions
Key Takeways:
- Payroll deductions refer to the sum of the amount detected from the employee's wages.
- Understanding the difference between Pre-tax and Post-tax.
- Deductions are classified into two major types: voluntary deductions and involuntary deductions.
- Voluntary deductions are deducted based on individual interests such as health insurance, dental insurance, etc.
- Involuntary deductions are deducted from the employee's salary based on federal and state taxes such as FICA, Federal income, State income, etc.
What are payroll deductions?
Payroll deductions are deducted from the gross amount of the employee's paycheck to pay federal and state taxes, medical insurance, retirement plans, and other benefits. This is one of the important factors to differentiate gross pay and net pay. It can't be the same for all employees, they can vary based on the employee's paychecks.
Pre-tax vs post-tax: What’s the difference?
Pre-tax: Pre-tax is the taxes withheld from the employee's paychecks before any taxes are withheld. Pre-tax deductions reduce the taxable income so that employees can pay lower taxes for the year.
Examples of pre-tax deductions are:
- Health insurance
- Group term insurance
- Retirement plans
Post-tax: Post-taxes are the taxes withheld from the employee's paycheck after all the required taxes are withheld. They reduce the net pay of the employees, so the employees owe taxes on them.
Examples of post-tax deductions are:
- Roth IRA retirement plans
- Disability insurance
- Donations to charity
- Wage garnishments
Different types of payroll deductions
Payroll deductions can be categorized into two basic types:
- Voluntary deductions
- Involuntary deductions
Voluntary deductions
Voluntary deductions are the sum of money deducted from the employee's paycheck with the employee's consent. It is completely optional for the employees. An employee must opt in if they want to take part in certain benefits. This includes pre-tax and post-tax deductions.
Examples of Voluntary deductions are:
- Medical insurance
- Group life insurance
- Retirement plans
- Other benefits
Involuntary deductions
Involuntary deductions are the sum of money deducted from the employee's paycheck as mandated by laws. Every employer must opt a certain amount from the employee's paycheck and report it to the IRS. Employees are not given any option to opt out of these deductions.
Examples of Involuntary deductions are:
- Federal income withholdings
- State income Withholdings
- FICA taxes (social security and medicare taxes)
- Wage garnishments
How do payroll deductions work?
Payroll deductions are always processed for every pay period based on the tax laws applicable to them. The calculation can be done either manually or using automatic payroll software. Most businesses choose payroll software because it reduces errors while calculating payroll deductions. The amount that is withheld from each employee is based on Form W4(Employee withholding certificate), federal withholdings, and based on the rules provided in different states and cities taxes are deducted.
How do you calculate payroll deductions?
Payroll deductions can be calculated by using the following steps:
- Step 1 : (Essential employee document) - Employers must gather all the essential documents from the employees such as Form W4
- Step 2 : (Calculating the gross pay) - Gross pay contains all the deductions owed by the employee. Some deductions included in gross pay are total earnings before deductions, including wages, overtime, bonuses, or commissions.
- Step 3 : (calculate tax withholdings) - Calculate the federal and state income taxes are withheld from the employee based on the employee's earnings and using the information in Form W4. FICA taxes(Social Security and Medicare taxes) are withheld from employees based on the limits fixed by the federal.
- Step 4 : (Include all deductions) - Include all voluntary(Medical insurance, retirement plan) and involuntary deductions(federal and state tax income, FICA taxes) from gross pay
- Step 5 : (calculate the net pay)- Subtract all the deductions from gross pay to calculate the total net pay of the employee.
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Frequently Asked Questions About Payroll Deductions
Payroll deductions can be divided into voluntary and involuntary deductions. some examples of payroll deductions are
Voluntary deductions
Examples of Voluntary deductions are:
- Medical insurance
- Group life insurance
- Retirement plans
- Other benefits
Involuntary deductions
Examples of Involuntary deductions are:
- Federal income withholdings
- State income Withholdings
- FICA taxes (social security and medicare taxes)
- Child support order
- Wage Garnishments
Payroll deductions are reported by using the following forms:
- Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return
- Form 941, Employer’s QUARTERLY Federal Tax Return
- Form 944, Employer's Annual Federal Tax Return
Documents mentioned above must be filed via paper filing or e-filing method. Individual states might have a different set of rules for filing the payroll deductions.
Several types of deductions can cause errors while calculating payroll deductions. Employers should contribute certain taxes and other benefits to the employees. In case employers opt from employees for their contributions then it is included in examples of incorrect payroll deductions
- Federal unemployment tax (FUTA)
- State unemployment tax(SUTA)
- Workers’ compensation insurance
- Personal protective equipment required by OSHA
- Tools necessary to perform work
LTD (Long Term Disability) deduction refers to the contribution towards the long-term disability insurance policy. It provides financial benefits to the employees when they are extremely ill or injured. It helps the employees and their families from financial problems. The LTD plan is completely contributed by your employer.