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- Last Updated: 04/08/2025
What Are Payroll Deductions & How Do They Work?
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Payroll deductions are those carefully calculated amounts withheld from your employees' paychecks for income taxes, benefit payments, or other permissible reasons. Some are mandatory, while others may be voluntary. Proper management ensures these deductions run smoothly in the background instead of becoming a costly monthly headache.
What Are Payroll Deductions?
Payroll deductions are amounts withheld from your employees' pay before they receive their net pay. These deductions cover certain designated expenses, such as taxes, benefits plans, and savings initiatives like retirement contributions.
When you process payroll, you subtract payroll taxes from the gross amount of wages an employee earns before they receive their paycheck for a given pay period.
Employers are responsible for correctly calculating these deductions and depositing the withheld funds to the appropriate agencies and designees.
Common payroll deduction examples include:
- Tax withholdings, including federal, state, and local income taxes, and Social Security and Medicare taxes
- Benefits premiums: This covers the employee's portion of medical, dental, vision, or other elective insurance plans
- Union dues: When applicable, they include the required payments for employees covered by a union agreement
- Retirement savings plan contributions: These are employee contributions to retirement plans, such as a 401(k) account
- Court-ordered payments: This includes garnishments for child support, alimony, or other legal obligations
- Voluntary charitable donations: This allows employees to contribute directly to charities through payroll deductions if offered by the employer
Payroll deductions can be a significant part of processing an employee's paycheck, but they may also be a necessary step for business owners to help employees meet their obligations, such as in the case of child support payments.
How Do Payroll Deductions Work?
Employers gather information about an employee's deductions from multiple sources as part of the payroll process. Your employees' W-4 form is typically the starting point for payroll taxes, while deductions for benefit elections might come from their authorization forms or online portal selections. Payroll departments may also receive court orders directing them to withhold a set amount of an employee's pay for garnishments.
A standardized procedure for collecting this information helps you maintain accuracy and compliance. If you have staff in multiple geographic locations, your business may need to adjust your payroll process to account for different state and local requirements, such as tax rates — adding layers of nuance to your payroll responsibilities.
As your business grows, payroll needs can grow, too. Your small business may reach a tipping point where it needs a more sophisticated payroll system or to outsource payroll to a trusted provider.
Types of Payroll Deductions
Some typical payroll deductions are mandatory for every employee, while others should only occur with an employee's written authorization. Your payroll department must identify pretax deductions — amounts removed from gross pay before calculating payroll taxes — to ensure compliance and maximize employee benefits.
Many types of payroll deductions fit into more than one category, adding to the complexity. Health care premiums, for example, can be both voluntary and pretax. You must review each deduction to ensure it's appropriately classified and handled throughout your payroll process.
Mandatory Payroll Deductions
Mandatory payroll deductions are amounts employers must withhold from employee paychecks by law, regardless of employee preference. The most common mandatory withholdings include federal and state income taxes, Social Security and Medicare contributions, and, where applicable, court-ordered wage garnishments. Employers are obligated to follow these non-negotiable withholdings and may face fines or penalties if they fail to do so.
Examples of mandatory payroll deductions include:
- FICA: In compliance with the Federal Insurance Contributions Act (FICA), you must deduct funds for the employee's share of Medicare and Social Security payments. As an employer, you also contribute a matching portion of these taxes.
- Federal income tax: Your employees complete Form W-4 to determine the federal income taxes you must withhold from their paychecks.
- State and local income tax: Depending on your location, you may need to withhold funds to cover your employees' anticipated state and local tax liabilities.
- Wage garnishments: When presented with a court order or IRS directive, you may be required to withhold specified funds from an employee's paycheck to recover unpaid debts, child support, or taxes.
Other mandatory deductions include funds for state-specific requirements such as state unemployment tax or state-funded disability program payments.
Voluntary Payroll Deductions
Voluntary deductions are optional amounts that employees can choose to have subtracted from their paychecks for various benefits, accounts, or services they've chosen to participate in. These deductions, which are separate from mandatory withholdings like taxes, can be used for benefits, retirement savings, and other optional programs. You'll take the requested amounts from the employee's gross pay before or after taxes, depending on the specific benefit type.
Your employees should authorize voluntary deductions — often, employees provide authorization during the annual benefits enrollment process, but some deductions, such as retirement contributions or charitable donations, can be adjusted at any time, depending on your company's policies.
Examples of voluntary payroll deductions include:
- Health insurance: Your employees' portions of healthcare premiums come out pretax when they join your company plan and there is a Section 125 Premium Only Plan. They can also set aside pretax dollars in health savings or flexible spending accounts to cover medical expenses, through a Section 125 Plan.
- Retirement plans: Your employees may take part in retirement plans, such as a 401(k), and you can deduct their contributions directly from their paychecks.
- Life insurance and disability plans: When your employees opt for group life insurance or short- or long-term disability coverage, you can deduct their premium payments.
- Other voluntary payments: Where state law allows, you can process deductions for charitable donations or wellness programs like gym memberships that your employees value.
Pretax Deductions
Pretax deductions are applied to an employee's paycheck before any taxes are calculated and withheld. Pretax payroll deductions reduce your employees' taxable income, thus reducing the amount of taxes they owe.
Common examples of pretax deductions include:
- Retirement contributions: Your employees can contribute a part of their salary to a retirement plan, such as a 401(k), before taxes
- Healthcare, dental, and vision insurance premiums: Employee-paid premiums for health and dental plans you provide as an employer are often deducted pretax
- Health savings account (HSA) contributions: If eligible, your employees can set aside pretax money for qualified medical expenses in a health savings account, in a Section 125 Cafeteria Plan
- Contributions to a dependent care flexible spending account (DCFSA): Pretax funds can be put in a DCFSA to cover eligible childcare or dependent care expenses, through a Section 125 Cafeteria Plan
As a business owner or HR manager, accurately applying these pretax deductions ensures that you don't inadvertently overcharge or undercharge your employees regarding tax obligations.
Post-Tax Deductions
Post-tax deductions, sometimes referred to as after-tax deductions, are amounts your payroll system processes after calculating all taxes. Unlike pretax deductions, these do not reduce taxable income. When your team processes payroll, you'll first handle all pretax deductions and tax withholdings, then apply these post-tax deductions to the remaining earnings.
Your business may need to process several types of post-tax deductions:
- Life and disability insurance premiums: Some premiums must be deducted after taxes. An exception: the first $50,000 of a group term life premium can qualify as a pretax deduction.
- Wage garnishments: Court-ordered deductions for debts like child support, unpaid taxes, or loan repayments are post-tax deductions.
- Charitable contributions: Employee donations to nonprofit organizations, if offered by your company, are taken out after deducting taxes.
- Union dues: Membership fees for employees covered by a union agreement are deducted post-tax.
How To Calculate Payroll Deductions
To accurately convert employees' gross pay to net pay, you must calculate payroll deductions in compliance with applicable laws. Your company's attention to detail and understanding of which deductions apply before taxes, and which apply after is crucial to go from gross to take-home pay.
Here's how to calculate payroll deductions:
- Start with gross earnings and subtract pretax deductions: Reduce your employee's gross pay by any pretax contributions to health, dental, and vision insurance premiums, 401(k)/403(b) plans, HSAs, and FSAs.
- Calculate federal income tax withholding: Use your employee's W-4 form and current IRS tax tables to figure out the correct federal income tax amount to deduct.
- Apply FICA taxes: Withhold 6.2% for Social Security (up to the IRS annual wage limit) and 1.45% for Medicare from your employee's adjusted wages. Employees earning over $200,000 per year require an added 0.9% Medicare tax.
- Determine state and local income tax: Calculate any state and local income taxes according to your location's specific requirements and tax rates.
- Process post-tax deductions: Subtract garnishments, Roth retirement contributions, post-tax insurance premiums, and other authorized deductions.
Be sure to document and double-check your calculations before finalizing payroll. This will help you ensure that your employee and business records are accurate.
Payroll Deduction FAQs
Still have questions about payroll deductions? Check out these frequently asked questions.
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What Are Some Examples of Incorrect Payroll Deductions?
What Are Some Examples of Incorrect Payroll Deductions?
With so many different types of deductions, even careful employers can make mistakes. Withholding too much or too little from a paycheck can cause financial hardships for your employees who may be subject to penalties from the IRS and other agencies.
Furthermore, taking deductions that don't follow federal, state, or local payroll laws can result in fines and penalties for your business. Here are some of the more common examples of incorrect payroll deductions:
- Non-compliant deductions: Many jurisdictions strictly regulate which deductions require employee consent and whether they must be taken pre- or post-tax. Taking unauthorized deductions from your employees' paychecks can have negative consequences for the employer.
- Incorrect tax calculations: While complex, accurate tax calculations are essential for business compliance. Misclassifying deductions as pretax or post-tax, improperly handling overtime or bonuses, or not updating an employee's tax status can lead to significant withholding errors on your payroll.
- Incorrect deduction amounts: For many voluntary deductions, employees often select specific amounts or coverage options that affect deduction levels, such as who in their household is covered by a benefit plan. If any of these variations are documented incorrectly, it can result in the wrong amount deducted from an employee's paycheck.
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How Do You Report Payroll Deductions?
How Do You Report Payroll Deductions?
To report payroll tax deductions correctly, you'll need to file specific forms with the IRS according to set schedules. For most businesses, this means submitting Form 941 quarterly to report all federal taxes withheld from employee paychecks. Smaller employers may qualify to use Form 944 annually instead.
Additionally, you must file these year-end documents:
- Form 940: Reports all federal unemployment taxes withheld during the year.
- Form W-2: Provides each employee with a record of their annual income and withheld taxes.
In addition to federal reporting requirements, your business may have state or local reporting obligations. These can vary significantly depending on the jurisdiction. In general, if your business operates in a state with income tax, you must withhold, report, and remit state (and sometimes local) income taxes using the appropriate forms for your jurisdiction. Many states also require employers to manage deductions for specialized programs like disability insurance or state-operated workers' compensation funds.
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When Can an Employee Change Their Voluntary Deduction Amounts?
When Can an Employee Change Their Voluntary Deduction Amounts?
Benefit premiums are the most common voluntary deduction, and they're typically managed through a Section 125 plan that you set up for your employees. These plans allow your employees to voluntarily set aside pretax money to cover expenses such as childcare or certain medical costs. Employees can typically only change or cancel the deduction amounts for benefits during the employer's annual open enrollment period, which varies from employer to employer. However, specific life changes create opportunities for adjustments, such as the birth of a child, marriage, divorce, or loss of other coverage.
Remember that employees can change their tax withholding status at any time by completing a Form W-4 or a state form and can adjust deposits to savings or other accounts whenever needed. Similarly, employees taking part in retirement plans generally can change their deferral elections at any time.
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What Are Basic Payroll Withholdings?
What Are Basic Payroll Withholdings?
Basic payroll withholdings are the mandatory deductions employers must take from employee paychecks to comply with federal, state, and local laws. These typically include federal income tax (based on W-4 information), Social Security tax (6.2% of wages up to the annual limit), Medicare tax (1.45% of all wages, plus 0.9% additional for high earners), state income tax (where applicable), and any required local taxes.
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Are Payroll Deductions Recorded As Liabilities?
Are Payroll Deductions Recorded As Liabilities?
Payroll deductions are recorded as liabilities in your company's books until you remit them to the proper recipients. When you withhold money from employee paychecks, these funds aren't yours — they represent amounts you're obligated to pay to tax authorities, benefit providers, or courts. From an accounting perspective, these withheld amounts create short-term liabilities on your balance sheet until payment. Tracking these obligations protects your business from costly penalties while ensuring accurate financial reporting that you and your stakeholders can trust.
Get Help With Your Payroll Process
As your company grows, the payroll process increases in complexity — adding risk and consuming valuable time you could spend growing your business.
Professional payroll services reduce this burden. Working with payroll experts who stay current with changing regulations gives you peace of mind, knowing your payroll is handled correctly, and allows you to focus on what you do best — running your business.
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