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What Is A Payroll Deduction Plan? – Forbes Advisor

What Is A Payroll Deduction Plan?
Written by publisher team

The first thing that you must understand is there are two basic categories of deductions:

  1. Pre-tax deductions: The deductions that must be made from the gross salary before calculating taxes are the pre-tax deductions. Pre-tax deductions help employees in decreasing taxable income.
  2. Post-tax deductions: The deductions that are done after calculating taxes are the post-tax deductions. They do not reduce the tax burden of the employees.

The salary calculated after both pre-tax and post-tax deductions have been done is the employee’s net or take-home salary. The pay stub that you generate with each payout must have all the details of deductions that have been done.

Payroll deductions can be categorized further into standard deductions, wage garnishments and benefit deductions.

Standard Payroll Deductions

Standard payroll deductions are deductions mandated by government agencies to pay for public programs and services. They make up the pre-tax deductions.

  • Federal income tax: The federal income tax has seven brackets from a minimum of 10% to a maximum of 37%. The amount withheld from an employee’s pay depends on the employee’s earnings and the information the employee provides on Form W-4. The W-4 form includes information about an employee’s tax filing status, how many dependents they have, income from other jobs, and any adjustments to the standard withholding amount.
  • Federal Insurance Contributions Act (FICA) taxes: FICA deductions are for employee Medicare and Social Security. Medicare costs 1.45% of the gross pay, whereas Social Security costs 6.2%. As the employer, you must match employee contributions 100%. For 2022, you must withhold and pay Social Security taxes on the first $147,000 of an employee’s gross pay. There is no Social Security tax on earnings in excess of $147,000. You must collect Medicare taxes on all the employee’s earnings. In addition, once an employee earns $200,000 in a calendar year, you must begin deducting an additional 0.9% Additional Medicare Tax from the employee’s pay.
  • State income tax: All except nine states levy income taxes on earnings. They either have a fixed rate against all income or multiple brackets. Your payroll software should be able to take care of state income tax for all your employees, depending upon their area of ​​residence or employment, whatever is applicable.

Wage Garnishments

If an employee has an unpaid debt, a court or government agency may issue a wage garnishment order. Wage garnishments are post-tax deductions.

Examples of wage garnishments include:

  • Child support
  • Student loans
  • Credit card debts
  • Alimony

The garnishment order will have details about the amount you must deduct from the employee’s pay, where the deductions should be sent. There are limits to the amount that can be garnished, and these vary depending on the employee, the applicable state and federal laws, and the type of debt. You should be very careful about deducting the right amount because if you fail to do so, you are potentially liable for the debt.

Benefit Deductions

If you offer company benefits like health insurance and a 401K plan, you’ll need to deduct employees’ costs or contributions from their pay. These voluntary deductions may be pre-tax or post-tax, depending upon the type of deduction.

Here are some examples of benefit deductions you might make:

  • 401(k): A 401(k) is a retirement plan funded by employee contributions. The IRS has increased the annual 401(k) contribution limit to $20,500 in 2022. Employees aged 50 and up can make an additional $6500 catch-up contribution. An employer can also contribute matching funds to employees’ 401(k) accounts. Employee 401(k) contributions are subject to FICA taxes but not income tax.
  • Payroll Deduction Individual retirement account (IRA): In this type of retirement plan, the employee sets up a traditional or Roth IRA with a financial institution. The employer deducts the employee’s desired IRA contribution each pay period and forwards it to the financial institution. This is simpler and easier for the employer than a 401(k) plan but is likely to be less popular with employees because there’s no employer match and the annual IRA contribution limit is only $6000 ($7000 for those 50 and older).
  • Medical, Dental and Vision Insurance: As health insurance costs have sourced, most employers now require employees to contribute to the cost of company-sponsored insurance plans. These contributions are pre-tax (and the employer’s contribution is not taxed) if the insurance is offered under a Section 125 plan, also known as a cafeteria plan.
  • Other Cafeteria Plan Benefits: In addition to health insurance, your company’s cafeteria plan may offer such benefits as disability insurance, health savings accounts and flexible spending accounts. These benefits are typically pre-tax.
  • Group term life insurance: The cost of group term life insurance plans may or may not be taxable, depending upon the specific plan and amount coverage.
  • Job-related equipment like uniforms: Federal law prohibits you from deducting the cost of uniforms if it would cause the employee to earn less than the minimum wage. Some states further restrict or prohibit these deductions, so be sure to check state laws before starting them.

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