Calculating employee payroll can be a tricky business, especially when you add in pre-tax deductions, after-tax deductions and payroll taxes. It doesn’t have to be all that complicated, especially if you work with a payroll company (like Journey Employer Solutions) to ensure your employees’ payroll checks are accurate.
What are pre-tax deductions?
Simply put, subtract pre-tax deductions from an employee’s gross wages prior to calculating their tax withholding. This lowers the employee’s taxable wages, which in turn lowers their tax liability because they tax based on that reduced amount. That doesn’t mean that the employee will never pay the tax, they simply defer some of the taxes. We’ll get into that a little later.
First, let’s discuss exactly what a pre-tax deduction looks like.
Health Insurance is one of the most common pre-tax deductions. Under this category, the employee can pay their share of the premium through pre-tax deductions. Depending on the policy, you can include medical, dental, and vision benefits. Important to remember: pre-tax insurance premiums are not qualified medical expenses on individual tax returns. These deductions are already excluded from the employee’s taxable income. See IRS Publication 502 for more information.
Life insurance coverage is and is not a pre-tax deduction. Employee paid premiums for the first $50,000 of employer provided group-term life insurance are pre-tax deductions. Insurance coverage in excess of $50,000 is considered taxable income by the IRS. If an employee has $150,000 in coverage, the taxable amount is on $100,000 of the coverage amount.
FSAs and HSAs
Flexible Spending Accounts and Health Savings Accounts allow employees to pay for qualified health care costs such as medical office co-pays, medical equipment and prescriptions, as well as procedures not covered by the employee’s health plan, such as LASIK surgery.
You can use Flexible Spending Accounts for eligible, work-related dependent care expenses for your dependent children or relatives. These expenses include (but are not limited to) before- and after-school care, pre-school, nanny and au pair services, summer camp, and elder care.
A qualifying dependent child is under age 13 and lives with the employee for more than half the year. A spouse or other qualifying dependent is over age 13 and physically or mentally incapable of self-care. This dependent must live with the employee for more than half the year.
Retirement Contributions, such as employer-sponsored 401(k), 403 (b) or traditional IRA accounts lower your Federal & State Withholding wages. Keep in mind that they defer taxes on these monies — ultimately you do have to pay them (sorry). As long as the funds stay in the account, they are tax-free. Once someone withdraws the funds, that’s when the taxes require payment. Typically this happens during retirement, when there’s a chance the earnings are at a lower tax rate.
Roth IRAs and annuities are after-tax deductions. During the savings years, contributions are eligible for taxes, but after the individual turns 59 ½, both the earnings on the account and withdrawals are tax free.
Here’s a quick Federal Paycheck Calculator that gives an idea of how pre-tax deductions impact your personal bottom line. “While this calculator can give you a general idea of what you can expect your paycheck to look like when pre-tax deductions are figured in, call a payroll professional for the most up-to-date and accurate deductions,” advises Ashlee Faulkner of Journey Employer Solutions. “Making a mistake here can negatively impact your employees and come back to haunt you if it is done incorrectly. It’s best to get it right — right from the start.”