For any small or big business owner, paying your employees is a very critical component. Besides making sure that you pay your workers on time, it is equally important to make sure that you are making accurate payments. It, therefore, means that you will need to have a good grasp of the payroll deductions like benefit premiums and taxes that come from every employee’s paycheck.
Understanding everything about payrolls can be a bit hard since that involves a lot of things. In this post, we explain everything that an employer needs to know about payroll deductions and taxes. By the end of this post, you will find it very easy to understand these deductions.
What Are Payroll Deductions?
First things first, what is payroll deduction? Simply put, payroll deductions definition is the wage garnishment, tax, and benefit payment that the employer withholds from the employee earnings. They are also famously known as paycheck deductions.
As an employer, you will be required to withhold the paycheck deductions for every employee to issue the W-2 form. This should, however, not be the case for independent contractors or the freelancers that you work with.
What Are Mandatory vs. Voluntary Payroll Deductions?
Payroll deductions are categorized as mandatory or voluntary payroll deductions. You might be wondering what the difference between the two is, and that is what we wish to elaborate on:
- Mandatory payroll deductions- These are the deductions that comprise all the payroll taxes and wage garnishments. All the state, federal, local income taxes and FICA taxes are ideally mandatory payroll deductions. In short, mandatory payroll deductions refer to the wages that will be withheld from an employee’s paycheck to meet the income tax and other needed commitments.
- Voluntary payroll deductions- These comprise the benefit-related deductions. For example, the contributions for retirement plans and the benefit premium payments are voluntary payroll deductions.
What Types of Payroll Deductions Are There?
We have just classified payroll deductions in two broad categories above. All the same, it is worth noting that there are so many types of payroll deductions out there.
In the section below, we discuss the most common deductions that you should know
Federal Income Taxes
These are the taxes that are used to pay for the operating expenses of a federal government. Federal income tax is generally built on some progressive tax system, with the high-income earners getting taxed at a higher rate.
However, it is essential to understand that the federal income tax withholding rate for every employee will differ. To correctly calculate the rate, you will be required to use the IRS Form W-4 that employees complete immediately after being hired. This tax is among the two common types of federal payroll taxes.
Medicare And Social Security Taxes
Under FICA, employers are required to withhold the medical and social security taxes from an employee’s paycheck. FICA taxes are in the second category of payroll taxes, and the rates are uniform among all the employees.
All the same, these rates are subject to change every other year. As of 2020, employers were required to withhold 6.2% of every employee’s initial $137700 of their wages. That would cover the social security taxes. To cover the Medicare taxes, the employer was required to withhold 14.5% of every employee’s wages without the wage cap.
As part of the employment taxes, different from the payroll taxes, the company must pay the FICA taxes from business income.
The only exemption will be when your company is a pass-through entity. These are taxes levied on the company’s income at a similar rate as the employee’s wages. All the same, unlike the employee contributions, the FICA employer contributions are entirely tax-deductible.
State Income Taxes
These are simply the state equivalent of the federal income taxes. The withholding rates for state income tax vary by both the state and the employee. You also need to know that some states will never collect the income tax whatsoever. As is the case for the federal counterparts, the state income taxes are similarly payroll taxes.
To put it, state income taxes are the direct taxes that the state levies on an individual’s income. This income is the wage that you earn from or in your state.
Local Income Taxes
In different states, individual jurisdictions or municipalities do collect the local income taxes too. Based on the location, the payroll tax can be based on your workplace or where you reside. According to the tax foundation, municipalities in only 17 states do collect the local income taxes.
You need to understand that the local income taxes generally apply to those people who work or reside in a particular locality. If you are an employer, you must pay attention to the local taxes where the employees are working.
These are payroll deductions ordered by the court and are used to pay for the employee’s child support needs and other legal obligations, including debt. In case your company gets a writ of garnishment for any of your employees, you are needed to acknowledge it is not more than seven days.
Additionally, you will be needed to start withholding the necessary funds in seven days from when you received the writ. Your employees can contest a writ of garnishment.
Similarly, the employer can do so if you receive the writ of garnishment for somebody who is not your employee. You need to understand that failure to acknowledge the writ of garnishment, you will be liable for the debt.
It does not matter whether it belongs to someone who is not your employee.
If your company offers health insurance to an employee’s benefits, the employee will be responsible for paying a portion of that. These are payments that are deducted from every employee’s paycheck.
Additionally, you can use the payroll tax deduction to expedite the employee’s payments for the life insurance premiums. Insurance premiums are paid for the policies covering healthcare, home, auto, and life insurance. Once earned, the premium becomes income for the insuring company.
If your company offers some retirement benefits, employees decide to have part of their wages withheld to contribute to the retirement plan. You can set up an individual retirement account or a 410 (k) retirement plan. This way, you will set up the payroll to redirect the money into the employee’s retirement account.
Last but not least, job-related expenses add to the list of the payroll deductions out there. Specific jobs do incur particular expenses for their employees. Examples of such expenses will include work expenses, home internet plans, personal computers, work phones, and tablets. Additionally, union dues are also included in this particular category.
How Are Payroll Deductions Reported?
You are required to report the mandatory payroll deductions on the tax forms. In the case of FICA taxes, report and pay the payroll deductions via IRS Form 941. For rare cases, though, IRS will instruct your company to do that using Form 944 instead. Every local and state taxation department should have its required forms too. The process of reporting the wage garnishments will vary by the category of garnishment too.
What Are Pretax Deductions?
These deductions are removed from an employee’s wages before the taxes are calculated. Most retirement plans, like the 401(k), are examples of pretax deductions. It simply means that the contributions made to any 410 (k) aren’t subject to the income tax. Pretax deductions reduce the taxable income and the amount of money that is owed to the government. This is because they are normally excluded from the gross pay for taxation. Ideally, pretax deductions usually are taken from the employee’s paycheck before any tax can be withheld.
What Are Incorrect Payroll Deductions?
This term ideally classifies the instances when deductions are wrong. There are so many reasons for that, which include:
- Withholding too much money
- Money being withheld for the wrong purpose
- Withholding inadequate money
- Money that has been withheld should not have been withheld
The typical examples are based on pay miscalculations where the employee classification is wrong in the first place. This is especially the case when some of the employees receive 1099. Missing deadlines as well as failure to update the records of the company could also lead to that.
Payroll deductions are a tricky aspect for any business, whether small or large. It is essential to remain updated with all the information about these deductions. If this is not the case, your business might be subject to legal penalties and fees for not complying with the tax obligations.
Above is a well-researched article about payroll deductions. Therefore, as an employee, you will know what to deduct from your employees’ wages and how to do that correctly. From what we have discussed, there are two main types of payroll deductions, namely mandatory and voluntary deductions.
Understanding the difference between the two is an excellent way to calculate deductions correctly. Making accurate payments is one of the strongest pillars to running a successful business.