Demystifying Payroll Deductions: Pre & Post Tax Calculations

Payroll deductions require accurate calculations to ensure your organization remains compliant. Here we help demystify payroll deductions with an overview of pre and post-tax calculations.

What are Payroll Deductions?

Employers are required by law to make payroll deductions from employee payroll by withholding a portion of total earnings to pay taxes, garnishments, and benefits. They are an essential element of payroll calculations as withholdings include income and social security tax which the government oversees. If calculations are not correct, you create risks for your organization, as well as for your employees. 

You must remit withholdings to the IRS, which is then applied as a credit against the employee’s annual income tax bill. The employee will owe the IRS money if you don’t withhold enough. You can face fines and penalties if you don’t remit the taxes on time or with the correct amounts.

Types of Payroll Deductions: A Detailed Exploration

Here we provide a detailed exploration of the types of payroll deductions.

Mandatory Payroll Deductions

Mandatory payroll deductions are required under tax laws and include the following:

1. Federal Income Tax

You must withhold and pay federal income tax on your employees’ behalf based on their gross pay or wages and information provided on employee W-4 forms. The W-4 tells you whether employees are married or single, the number of dependents, and whether they would like more money withheld from their pay.

2. Federal Insurance Contribution Act (FICA)

This act is divided into two federal programs:  

• • Social Security: The employer and employee contribute to social security to fund the Old-Age and Survivors Insurance Trust Fund (OASI) for retirement and the Disability Insurance Trust Fund (DI) benefits.
  • Medicare Insurance: Employers and employees also contribute to Medicare insurance which goes towards the Hospital Insurance Trust Fund and Supplementary Medical Insurance Trust Fund to help cover medical fees when workers are sick.

3. The Federal Unemployment Tax Act (FUTA)

FUTA is a federal withholding tax paid by employers to compensate people who lose their jobs through no fault of their own.

4. State and Local Taxes

State taxes are also based on gross pay and the rate set by the state. This can get tricky to track if you operate in various states, as some states don’t have income taxes. On top of federal and state taxation, some cities and municipalities have payroll withholding requirements. These are paid by employers and employees and cover local maintenance and improvements. 

There is also the State Unemployment Tax Act (SUTA), also known as State Unemployment Insurance (SUI) or reemployment tax depending on the state. SUTA is usually funded by employers. Each state sets its own rates and will inform you of the required contributions when you register as an employer.

5. Wage Garnishments

Wage garnishments apply to specific employees ordered by the courts to pay outstanding balances. These debts are paid via withholdings related to child support, alimony, defaults, etc. You will receive a “writ of garnishment” informing you of the amount to withhold and how long the deductions are required.

All withheld federal income taxes, social security, and Medicare funds must be paid to the IRS, based on either a semi-weekly or monthly payment schedule to remain compliant with tax deposit rules. You then must file a quarterly report on Form 941 or annually on Form 944 to provide an overview of the wages paid, your employment taxes, and the tips your employees report. Each individual state also has tax deposit rules you will have to follow.

Voluntary Payroll Deductions

Voluntary payroll deductions are either pre-tax made before tax withholding or post-tax made after tax withholdings.   

What is a pre-tax deduction?

You deduct pre-tax deductions before tax withholding, reducing your employee’s taxable income as well as how much each employee will owe the government. 

Pre-tax deductions include:

• • Health Insurance
  • Retirement Contributions
  • FSAs & HSAs
  • Transportation & Commuter benefits
  • Other benefits

What is a post-tax deduction?

You deduct post-tax deductions after tax withholdings, so they don’t lower your employees’ taxes. Post-tax deductions include:

• • Roth contributions
  • Union dues
  • Court-ordered deductions
  • Voluntary retirement contributions
  • Garnishments

What types of deductions are optional?

Employees can choose to decline participation in post-tax deductions unless they are court orders or garnishments.

Job-Related Expenses and Reimbursements

Common examples of job-related expenses include:

• • Uniforms
  • Meals
  • Travel
  • Supplies
  • Union-related taxes and benefits

Keep in mind, some states prohibit job-related deductions, so it is important to understand the rules in the areas you operate.

Calculating Payroll Deductions: Math Made Simple

To help simplify payroll deduction calculations, you can use these tips:

Understanding Deduction Calculation Methods

It helps to follow basic steps to better understand calculation methods:

• Always review W-4s and the most current IRS tax tables to ensure you make the correct deductions for each employee
• Review wage limits so you can withhold the required 7.65% of adjusted gross pay for Medicare tax and Social Security tax correctly
• Once the year-to-date income reaches $200,000, be sure to deduct 0.9% for additional Medicare tax
• When doing payroll in states with income tax, be sure to follow the specific instructions based on each state’s tax guide or tax code
• When tallying total net pay, remember to subtract post-tax dues such as contributions to Roth IRA retirement plans

Handling Deductions for Different Employee Categories

There are two types of categories:

1. Non-exempt: Non-exempt employees are entitled to an hourly minimum wage and overtime pay when they work more than 40 hours per week under the Fair Labor Standards Act.
2. Exempt: You do not have to pay overtime for exempt employees paid a salary, although you can choose to do so through your benefits package.

Compliance and Recordkeeping – Tips for Business Owners

To help keep on top of payroll deductions and remain compliant, use these helpful tips:

• Maintain proper documentation and records: Proper records and backup documentation are a must to make tax audits stress-free and prove you are complying with state and federal tax rules.
• Conduct regular audits and reviews: Proactively monitoring every payroll ensures everything is accurate and filed on time every pay cycle.
• Employee education and communication strategies: Annual changes and different state regulations call for ongoing education to ensure payroll staff are always up to date.
• Integrate payroll systems with third-party administrators: Using effective payroll software backed up by tax specialists ensures deposits are correct. The experts provide ongoing audits, while the software does everything needed to assist with compliance and record keeping including reporting, tax filing, direct deposit, integrations, mobile access, and more.

Pre and post-tax calculations are simple to manage with effective payroll software. The software reduces the risk of penalties related to non-compliance and improves efficiencies through automated workflows.

Discover Paypro’s top-rated, customizable payroll software here, or set up a free consultation.
 

About the Author

Kayla is the Marketing Manager at Paypro Corporation overseeing all inbound and outbound marketing and sales efforts. She has 7+ years of experience working within the B2B and SaaS based solutions space and thrives on creating messaging and campaigns that introduce products and services to those who need them most.