What are payroll deductions?

Paying your employees on time is a mandatory requirement for any business, no matter the size. However, paying the appropriate amount in payroll deductions could probably tie for first place in a race of importance.

It’s imperative that you—the business owner—to understand payroll deductions, what deductions are mandatory and which are voluntary, and where to send the deductions once they’ve been taken.

In general, there are two types of deductions: pre-tax and post-tax. There are also mandatory and voluntary deductions. All of these are listed below. Here is your quick and easy guide to determining your payroll deductions.

Pre-tax

Income tax: Income taxes are made up of two general taxes—FICA (Federal Insurance Contributions Act) and federal income tax.

FICA is made up of the Social Security and Medicare taxes. As of September 2019, FICA accounted for approximately 7.65% of a worker’s earnings on salaries up to $127,200. Here’s the breakdown:

The total amount of taxes paid to the federal government is 15.3%. Employers must deduct 6.2% from their employees’ pre-tax pay for Social Security, as well as 1.45% for Medicare. Then, employers must pay a matching amount for a total of 15.3% in federal income tax.

State & local taxes: Every state has its own tax structure. Consult this site for more information regarding your state’s requirements.

A note about state income tax: If you work in one state, and all of your employees live in that state, then the state sales tax you’ll owe is pretty straightforward. However, if you have multiple offices in different states or remote employees in different states, your state payroll deductions will be a bit more complicated.

The easiest thing to do is to consult a tax professional with experience in multi-state businesses. Also, don’t be afraid to use each state’s tax agency as a resource.

Post-tax

Garnishments: These are a special case if an employee has unpaid debt. Wage garnishments are ordered by the court and can come from the IRS, state agencies or other non-tax government agencies.

To garnish an employee’s wages, you will receive a garnishment order from the proper agency outlining all of the requirements, including how much to garnish, a start date and where the garnished wages should be sent. The stop date may be dependent on several variables, so just be sure to closely adhere to the garnishment order.

Employee tax contributions

Using a W-4 form , your employees can also choose to have a certain amount deducted from their taxes. Deductions are decided by a bunch of parameters—the W4 serves as both a form and an instruction sheet for the employee. You can also recommend that they use this calculator available from the IRS.

Pre-tax

Health insurance premiums, including health savings plans, are pre-tax deductions. This assumes that your business is able to offer health insurance to your employees.

Pre- and post-tax

Retirement plans and life insurance can be pre- or post-tax deductions. In general, 401(k)s are pre-tax, while others, like a Roth 401(k), are post-tax. The same is true of life insurance, disability insurance and job-related expenses, such as uniforms, union dues and meals.

Depositing and reporting

Once you have deducted the necessary payroll taxes, including Social Security and Medicare, they must be correctly deposited and reported to the IRS and/or state tax agency.

Depositing

You must use a direct deposit system for all federal taxes. It is called the electronic fund transfer system (EFTPS), and deposits must be made on a set schedule. Details regarding the schedule can be found on the IRS website.

Paying state sales tax will depend on your state’s tax agency. Use this link to find contact information for your state’s tax agency.

Reporting

You must also submit reports to the federal and state agencies. For federal taxes, Forms 940, 941 and 944 must be submitted on paper, or via e-file. State agencies will have their own rules and forms for reporting, so be sure to check with them on the proper procedure.

Payroll deductions and reporting can be complicated, but by utilizing the proper resources and paying attention to detail, your small business shouldn’t have any issues.