Payroll Deductions: What Are They and How to Make Them

Hiring your first W-2 employee is a significant milestone for many small business owners. It acknowledges that your efforts are paying off and that you require additional support to meet your long-term business goals. It also means more work for you now that you'll be responsible for running payroll and handling associated taxes each pay period.An important aspect of running payroll is the deductions you'll need to make on your employees' behalf for tax purposes. Use this guide to learn what payroll deductions are and how you can make them for your employees.

What are Payroll Deductions?

Money withheld from your employees' paychecks is called a payroll deduction. Some payroll deductions are mandatory, while others are only implemented with employee consent. Certain deductions are taken from wages pre-tax, while others are withheld from post-tax wages. Some of the most common deductions include income and Social Security tax withholdings.

These withholdings are for W-2 employees only. If you use freelancers or contractors, it would not be your responsibility to handle taxes on their wages.  

8 Types of Payroll Deductions

Use this guide to learn about different deductions you can apply to your employee payroll. Remember that some are mandatory, while others are voluntary and can only be included with the consent of your employees. 

Pre-Tax Payroll Deductions

Deductions you make on your employees' behalf before taxes are withheld are called pre-tax payroll deductions. While there are limits on how much money your employees are allowed to contribute, they should seriously consider taking pre-tax deductions. Because the money is taken out before it is taxed, these deductions cost less than they would if they were considered post-tax deductions.

401(k)

If you offer an employer-sponsored retirement plan to employees, contributions to a 401 (k) plan qualify as a pre-tax deduction. Like other pre-tax deductions, the Internal Revenue Service (IRS) has a strict limit on the amount your employees can contribute to this plan annually. 

Post-Tax Payroll Deductions

Deductions taken from your employees' pay after all required taxes are withheld are called post-tax payroll deductions. Most post-tax deductions are entirely voluntary, with a few notable exceptions. Because the money is withheld after it is taxed, these deductions cost your employees more than they would if they were considered pre-tax deductions. And unlike pre-tax deductions, post-tax deductions will not lower an employee's annual tax burden. 

Wage Garnishment

Charitable donations and retirement plan contributions are examples of voluntary post-tax payroll deductions. Wage garnishments, however, are post-tax deductions typically mandated by the courts, IRS, or other government agencies. The body or agency that has authorized the garnishment of your employee's wages will usually provide guidance in terms of the precise amount you must withhold. Wage garnishments can go toward fulfilling your employee's unpaid tax bill, alimony, and child support. 

Statutory Payroll Deductions

You will also be responsible for withholding money that goes toward programs and services that benefit the public. These are called statutory payroll deductions and are typically mandated by government agencies to be withheld. Statutory payroll deduction withholdings will go toward federal and state income taxes and FICA, the Federal Insurance Contributions Act. 

FICA Deductions

FICA payroll deductions go toward Social Security and Medicare. The Social Security tax rate for W-2 employees is 6.2% and 1.45% for Medicare. Employers must match those contributions, bringing the total contribution to 15.3%.You will not be responsible for making this contribution if you use freelancers or contractors. Instead, freelance or contract workers must pay the entire 15.3% from their income, which is called a self-employment tax. 

Federal Income Taxes

You must also withhold federal income taxes for your employees. Federal income tax withholdings depend on your employees' income and filing status. Income will fall in one of the seven tax brackets, while information regarding filing status can be found on each employee's respective IRS Form W-4.  

State and Local Taxes

Federal income tax withholding rules for payroll are fairly consistent wherever you operate in the country. That isn't true of state and local taxes, which can be more onerous in certain areas and friendlier in others. You must determine the appropriate amount of state and local taxes you must withhold from your employee's pay based on current rules and laws.

If you're having difficulty making that determination, consult with members of your state and local governments or schedule time to speak with a payroll professional. 

Voluntary Payroll Deductions

Some payroll deductions are mandatory, while others are voluntary. Employees can take voluntary payroll deductions on a pre-tax or post-tax basis or none at all. If they opt to take voluntary deductions, ensure they are clearly displayed each pay period. 

Insurance

Most Americans receive healthcare through an employer, and the employer and employees commonly contribute to the cost of insurance premiums. If you offer health insurance to your employees, premiums can be paid on a pre-tax basis. 

Retirement Plans

Retirement plan contributions can be made on a pre-tax and post-tax basis, depending on the option your employees choose. For example, contributions to a 401(k) can be made on a pre-tax basis, while Roth IRA contributions are made post-tax. 

Calculating Payroll Deductions

Calculating payroll deductions each pay period can be a time-consuming and detail-oriented process. If you're handling payroll yourself, here's what to do.

First, adjust each employee's gross pay by withholding voluntary deductions they've made, if any. Next, you will calculate their federal income tax deduction. Then, you will withhold the 7.65% for Medicare and Social Security, which you will also match. You must address applicable state and local income taxes and then subtract post-tax deductions to determine each employee's net pay for the period.   

Reporting Payroll Deductions

You must report payroll deductions and make payments to the federal government. Check with your state and local governments for any filing requirements they may have associated with payroll deductions.Use IRS Form 940, IRS Form 941, and IRS Form 944 to submit payroll materials and payments to the government. 

Payroll Made Easy: Let 1-800Accountant’s Experts Handle It

Understanding how these deductions apply is essential when handling employee payroll. These insights will help make the challenging, time-consuming process of running payroll each pay period a little easier. However, if you find that running payroll yourself has taken away from more pressing business matters, consider outsourcing.

When you outsource your payroll to 1-800Accountant, America's leading virtual accounting firm, our payroll experts handle payroll and associated tax filings for you. This frees you to focus on your next business milestone while we handle your employee pay. Schedule a quick consultation—usually 30 minutes or less—to learn how we can help your business flourish with payroll and other essential, tax-deductible financial services.