Pre-Tax Deduction

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Understanding tax responsibilities, withholdings, benefits, and contributions are part and parcel of payroll processing. And while it is true that businesses hire payroll providers to do all the calculations, having a clear understanding of the different aspects of payroll is always an advantage. Today, we’ll be talking about pre-tax deductions. 

What is the meaning of a “pre-tax deduction”? 

A pre-tax deduction refers to an amount of money that is subtracted from the gross wages of an employee before withholding taxes. Note that it says “pre-tax” which strictly means before taxes. 

If you are an employer, it is best to be updated on regulations on pre-tax deductions set by the Internal Revenue Service (IRS). Here are some examples of pre-tax deductions: 

What is the significance of pre-tax deductions? 

There are many benefits that employees may be offered at work. These benefits may fall under pre-tax or post-tax deductions. If you are just beginning to know what deductions are, you might wonder why it matters if something is a pre-tax deduction or a post-tax deduction if both will be deducted from the gross pay anyway?

Whether a deduction is pre-tax or post-tax is significant because of its impact on taxes. Because pre-tax deductions are subtracted before taxes are taken from the gross wages, they reduce the reportable W-2 income. They lower the taxable income of the employee. As a result, the employee may have lesser Social Security, Medicare, and income taxes. Additionally, pre-tax deductions can also result in lower federal unemployment tax (FUTA) and state unemployment tax (SUTA) for employers. 

On the other hand, post-tax deductions are taken after taxes are withheld. They have no bearing on an employee’s taxable income. 

A note to employers, know that the rules on pre-tax deductions can vary. Be vigilant and check everything before running your payroll. 

What are other examples of pre-tax deductions? 

 

Let us see an example of how a pre-tax deduction can be calculated. 

Anna is an employee who receives $1,200 each pay period. She has a health savings account (HSA) with a deduction of $50 per payroll period.

Remember that a pre-tax deduction is subtracted before withholding taxes from gross wages. This means that the $50 is taken out first. 

$1,200 -$50 = $1,150

Anna’s taxable income becomes $1,150 per pay period after taking out the pre-tax deduction. Withholding taxes are based on $1,150 and not on the original gross wages of $1,200.

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