Payroll Deductions

Deductions from an employee’s paycheck can be difficult to navigate. It can be a daunting task to understand not only the terminology, but adhering to rules set forth by the IRS while making sure deductions are setup and calculated correctly.

Pre-tax Deductions

A pre-tax deduction lowers an employee’s gross wages that are taxed. These types of deductions have specific rules and guidelines governed by the IRS to be considered pre-tax.

We will use employee Joe as an example. Joe made $1,200 this pay period. He has a pre-tax Section 125 health insurance deduction in the amount of $125 per pay period. The deduction lowers his gross taxable wages to $1,075. On Joe’s check stub below, his Social Security and Medicare taxes are calculated on the $1,075.

Social Security: $1,075 x 6.2% = $66.65 Medicare: $1,075 x 1.45% = $15.59

Some common pre-tax deductions are:

• Pre-tax Section 125 health insurance plans
• Pre-tax Section 125 health savings accounts (HSAs)
• Traditional IRA plans
• 401(k) plans
• 403(b) plans

Each of these has their own rules and not all are exempt from all Federal taxes. For example, an employee with a pre-tax 401(k) plan may reduce his gross wages from his current pay but when he withdraws from the 401(k) during retirement, taxes will be owed.

Post-tax Deductions

A post-tax deduction, also known as an after-tax deduction, is subtracted from the employee’s pay after the taxes are deducted first from the gross pay.

For this example, we will use Samantha’s paycheck. She made $900 this pay period. Her employer received a garnishment order and must deduct $45 per pay period after taxes are deducted from Samantha’s paycheck. As seen in her check stub below, her taxes were calculated on her gross wages of $900 and then the garnishment of $45 was withheld.

Social Security: $900 x 6.2% = $55.80 Medicare: $900 x 1.45% = $13.05

Just like pre-tax deductions, post-tax deductions have their own set of rules set by the IRS. A few examples include but are not limited to:

• Roth 401(k) plans
• Union Dues
• Garnishments
• Child Support
• Disability
• Life Insurance policies
• Non-pretax health insurance plans
• Non-pretax health savings accounts (HSAs)

Not only does an understanding of payroll deductions ensure compliance with the IRS, but it aids in budgeting and financial planning by providing clarity on labor costs. It also enables employers to make informed decisions about benefit packages and employee compensation, contributing to overall organizational effectiveness and employee retention.

Please contact the Payroll Team at DWD CPAs & Advisors to learn more about our payroll services.