Everything You Need to Know About Payroll Deductions

Companies need to pay employees for the work they do. But this isn’t as simple as writing a check for the number of hours someone works. That’s because employers have to withhold some funds from an employee’s gross income. 

Here’s everything you need to know about payroll deductions as an employer. 

What Are Payroll Deductions?

Payroll deductions are the money employers withdraw or withhold from a worker’s paycheck. Companies must do this before paying the employee for their work. Some payroll deductions are mandatory, also called statutory. Taxes are one example. Others are voluntary, like 401(k) contributions chosen by the employee.  

Say a worker earned $2,000 in a pay period. If they had $500 in deductions, they’d get a $1,500 paycheck. The employer would withhold that first amount. Some of it might go to the IRS to pay the required taxes. And some could be for a health insurer to pay the employee’s premiums.

Types of Payroll Deductions

Here are some common types of payroll deductions:

• Federal Insurance Contributions Act (FICA). Workers must pay into Social Security and Medicare. Taxes to fund these programs are called FICA taxes because they’re required by FICA. Most workers have 7.65% of income withheld for FICA taxes. Higher earners include single tax filers with incomes above $200,000 and married tax filers with incomes above $250,000. They have an additional 0.9% Medicare tax to pay. 
• Federal Income Tax Withholding. The U.S. tax system is a pay-as-you-go system. Employees fill out a W-4 form, which provides employers with the information needed to withhold the correct amount of taxes. These forms include personal details like the number of dependents employees have or any extra income that affects filing. Companies withhold that amount and send it to the IRS during the year. 
• State Taxes. States that charge taxes usually make employers withhold money to cover what workers will owe. All states have income taxes except Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. 
• Unemployment Insurance. In Alaska, New Jersey, and Pennsylvania, employers must withdraw money for state unemployment insurance. 
• Garnishment. Courts sometimes garnish wages to make people pay the money they owe. For example, a court might use this to collect money for unpaid taxes. Other common reasons include spousal support, student loans, or child support. When this happens, courts order employers to take the money from the worker’s pay.
• Workplace Benefits. Employees sometimes ask companies to take out money to contribute to certain workplace benefits. These include health, life, or disability insurance or union dues. If workers sign up to contribute to 401(k)s or flexible spending accounts (FSAs), employers also withdraw this money from their checks. 

It’s also important to note some deductions are pre-tax. You subtract these amounts from gross wages before calculating taxes due. They reduce the employee’s total amount owing. Examples include:

• Health insurance premiums
• Group term life insurance premiums
• Retirement plan contributions
• Contributions to FSAs

Which Types Are Mandatory Payroll Deductions?

Employers must take certain withdrawals out of a worker’s paycheck. Otherwise, the company could face criminal or civil penalties. Companies could also be responsible for paying the money they were supposed to collect if they can’t pay it. Examples of mandatory payroll deductions include the following:

• FICA taxes
• Federal and state income tax withholding
• Court-ordered garnishments

Employees can’t just choose not to have taxes withheld. And they can’t ask their boss to ignore a garnishment order. 

Voluntary deductions are different. Employees can opt to have this money taken out, but they don’t have to. Employers should provide all relevant information about voluntary withdrawals. It’s usually a best practice for companies to get written authorization from the employee before deducting the money. 

How to Calculate Payroll Deductions

Payroll services usually help calculate net pay for you. That’s the amount due after deductions. But here’s how payroll deductions work: 

1. Calculate Pre-Tax Deductions

Start by adding up any deductions employees can make with pre-tax funds. These include health and life insurance premiums, some commuting expenses, and FSA and retirement account contributions. 

Subtract the total amount of pre-tax contributions from the worker’s gross pay. That’s the total amount earned during the work period. Let’s say a worker earned $1,500. They paid $200 for health insurance and made a $100 401(k) contribution. You’d subtract $300 in pre-tax deductions from their $1,500. This leaves $1,200 in taxable income.  

2. Subtract The Employee’s Mandatory Tax Withholding

Now it’s time to see the impact of tax on payroll calculations. You’ll need to take out federal, state, and FICA taxes. The worker’s withholding status determines how much. The IRS has a withholding calculator to help calculate withholding status. 

Say the worker had $200 in mandatory tax withholding. The $1,200 left after their pre-tax deductions would now be $1,000. 

If employers withhold too much tax, employees can claim a tax refund when they file their returns. If companies withhold too little, workers owe a penalty. Make sure the right amount is withheld to avoid complications in tax season. 

3. Deduct The Employee’s Post-Tax Deductions

Next, subtract any post-tax deductions from what’s left of a worker’s check. These are things the worker is paying for with after-tax dollars. Court-ordered garnishments or Roth 401(k) contributions are examples.  

If an employee had a $100 garnishment order for unpaid child support, their $1,000 check would now be reduced to $900. The employer would send the other $100 to wherever the court ordered. 

Employers then pay the employee whatever amount is left. 

Best Practices to Calculate Payroll Deductions

Calculating payroll deductions accurately is the law. Fortunately, it’s easy with the right processes. 

Keep Careful Records

Every company needs detailed records of withholding rates, garnishment orders, and voluntary contributions. You can use a payroll journal to track this information. 

Track Hours Reliably 

Companies must get the initial gross pay correct. Everything is deducted from that amount. Time-tracking software and time clocks help companies with hourly employees keep the details straight. 

Make Sure Employees are Classified Correctly

Employers aren’t responsible for payroll deductions for independent contractors. 

Independent contractors invoice for work. They’ll get paid their gross amount. Then, they take care of their own IRS obligations. Be sure to understand IRS guidelines for when a worker is an employee versus an independent contractor.

Use a Payroll System 

You can choose from different payroll methods. Options include using software, manually processing payroll yourself, or outsourcing the job to a third party. You can also use a payroll deductions calculator. The right approach depends on your business needs, the number of employees you have, and your comfort level with complying with IRS rules and regulations. 

Joist Makes Payroll Easier

Managing your payroll is only one piece of the financial puzzle for business owners. You also need to track sales and issue invoices to clients. Luckily, Joist can help. Organize and automate your bookkeeping with QuickBooks Online Sync. You can spend less time keeping records and more time delighting customers while ensuring full compliance with payroll rules and regulations.