Payroll deductions: What they are, how they work, and 8 types

Paying your employees correctly and on time is key for any business. That means making sure you have all the necessary payroll deductions in order. As a business owner, you’ll need to understand which deductions are mandatory, which are voluntary, and where to send the deductions once they’ve been taken. Let’s look at how payroll deductions work and the different types: 

How payroll deductions work

Payroll deductions are wages taken out of employees’ paychecks to pay for costs like payroll and income taxes, employee benefits, and more. They determine an employee’s net pay, also known as their take-home pay. Payroll deductions can also be voluntary or mandated: 

Mandatory vs. voluntary payroll deductions

The law requires employers to pay mandatory deductions by sending them to tax agencies. Federally mandated taxes, such as FICA tax and federal income tax, are standard payroll taxes that must be taken out from an employee’s paycheck. Many employers choose to use a payroll provider to automate deductions and reduce errors.

Unlike mandatory payroll deductions, voluntary payroll deductions aren’t required by law. With employee consent, employers can take some deductions from their paychecks. An employee must opt in if they want to take part in certain benefits. 

Employers must make mandatory deductions, such as federal, state, and local taxes, but employees have the option to opt in or out of voluntary deductions. Paycheck deductions can also be pre-tax or post-tax. 

Pre-tax vs. post-tax deductions

Some payroll deductions happen before other taxes are withheld—known as pre-tax payroll deductions. Meanwhile, certain deductions are only taken out after tax withholding—these are known as post-tax payroll deductions.

Pre-tax deductions are taken from an employee’s gross pay before any payroll taxes are withheld. Like employee tax deductions, pre-tax deductions reduce an employee’s taxable income, which is the money they owe to the government. Common pre-tax deductions include health insurance and retirement plans.

On the other hand, employers withhold post-tax deductions from an employee's net pay. Common post-tax deductions include wage garnishments and job-related costs like travel. 

Types of payroll deductions

There are various payroll deductions that can either be mandatory or voluntary. Here are eight of the most common: 

1. FICA taxes

Mandatory payroll deduction

Federal Insurance Contributions Act (FICA) taxes include Social Security taxes and Medicare taxes. Employee and employer contributions for FICA are equal, with the current rate being 6.2% of gross wages coming out of an employee’s paycheck for Social Security and 1.45% going to Medicare. Employers match both of these contributions for a total of 15.3%.

If a company doesn’t report these taxes, it can get in trouble with the law. The amount an employee pays in FICA taxes per pay period depends on their pre-tax deductions, which lower their taxable income.

2. Federal income tax

Mandatory payroll deduction

The amount of federal income tax you’ll withhold from your employee’s paychecks will depend on their Form W-4. Each employee will fill out a W-4 form, one of these forms, and the amount of federal income tax withholding. 

Using a W-4 form, your employees can 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. 

3. State and local taxes

Mandatory payroll deduction

Like federal income taxes, state and local payroll taxes are mandatory payroll deductions and must be paid to the appropriate tax authorities. Each state sets its income tax rate. An employee’s gross income and any pre-tax deductions will determine the amount they pay in state and local taxes.

If you work in one state, and all of your employees live in that state, then the state 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 liabilities will be a bit more complicated.

4. Wage garnishments

Mandatory payroll deduction

Employees with unpaid debt or other obligations may have wage garnishments as payroll deductions. Wage garnishments are sent by a court or government agency like the IRS and require employers to withhold money from an employee’s paycheck. 

The deductions are on a post-tax basis and usually go toward debts or obligations like:

• Taxes
• Alimony
• Child support
• Defaulted loans. 

The wage garnishment letter will explain how much of an employee’s paycheck has to be withheld and where the money has to be sent.

5. Health, disability, and life insurance

Voluntary payroll deduction

Health insurance and other premiums are voluntary payroll deductions that are typically made on a pre-tax basis. If you offer health benefits for your employees, you can have them pay part of their premiums via paycheck deductions. This also includes other health benefits, such as dental insurance or health savings plans. 

6. Retirement plans

Voluntary payroll deduction 

As another employee perk, companies can offer retirement plans, such as a 401(k) plan that lets employees save for retirement. Employees can have a part of their paycheck withheld as a voluntary deduction and invested in their 401(k). 

An employer can offer a few retirement plan options, and the type of retirement plan will determine whether it’s pre-tax or post-tax. For example, money put into a traditional 401(k) can be pre-tax, while money put into a Roth IRA must be post-tax.

7. Union dues

Voluntary payroll deduction 

Members of unions usually make regular payments to the union they’re a member of. These dues are post-tax, so they won’t offer a tax benefit. 

Union dues can go toward an employee’s membership, along with other taxable benefits offered by the union, which are all deducted on a post-tax basis.

8. Job-related expenses

Voluntary payroll deduction 

Other job expenses an employee might deduct include:

• Meals
• Travel
• Uniforms
• Home office equipment
• Parking
• Transit
• Medical exams. 

These job-related costs are also deducted on a post-tax basis. 

Tips for managing paycheck deductions

Once you have all your payroll deductions in order, you’ll want a way to manage them effectively. 

Here are some tips for staying on top of paycheck deductions: 

• Ensure you have up-to-date employee records: This includes having a process in place for updating employee pay rates, addresses, and tax withholdings.
• Track employee hours reliably: Use time-tracking software or apps, paper timesheets, or time clocks to ensure precise payroll if you have hourly employees. 
• Create a payroll policy: Establish a clear policy outlining the payroll process, employee classifications, salary determinations, and reporting obligations. 
• Categorize employees accurately: Properly classify employees as hourly or salaried to comply with legal regulations, and adhere to the Fair Labor Standards Act (FLSA). 
• Invest in a payroll system: Pick a system that works best for your business, whether it’s manual processing, outsourcing, or using payroll software.

How you manage your payroll will depend largely on your budget and time available, as well as your confidence in keeping all your payroll tasks in order. 

Next steps for streamlining your payroll process

There are plenty of payroll deductions you need to know. From the mandatory ones to the voluntary ones—not to mention what should be withheld on a pre-tax vs. post-tax basis. Payroll software like QuickBooks Payroll can make managing all your payroll deductions seamless, including filing and paying your payroll taxes accurately and on time.



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