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Payroll deductions: Knowing what they are

Harish Sivakumar, Manager
march 15, 2021
Yellow sticky note with text displaying Payroll Deductions and a couple of binder clips scattered

If you have been working for a good deal of your adult life, you will be familiar with the term "Payroll deductions." Payroll deduction is a certain amount of money deducted from an employee's salary during every pay period. 

When inducted into a job, most employees are informed about two aspects: the gross pay and the net pay or take-home pay. The take-home pay is the amount that is left after the various deductions are subtracted. 

Not all deductions are mandatory. Some of them are voluntarily made by the employee after they provide written authorization to the employer. Mandatory deductions are part and parcel of the job and are mostly processed by the employers before the take-home pay is credited to the employee's bank account. 

A detailed look into mandatory and voluntary payroll deductions

Let's first deal with mandatory deductions that are made from your salary. As per the law, employers are responsible for withholding taxes from the employee's salary and submitting them to tax agencies. Flouting the rules and avoiding paying mandatory taxes will surely invite legal trouble.

Let's take a look at the mandatory tax list:

  • FICA tax

The Federal Insurance Contributions Act supports Social Security and Medicare. FICA tax deduction is common for both employers and employees. Employees whose income is at or below the Social Security wage base will pay a Social Security tax of 6.2 %. With Medicare tax at 1.45%, the FICA tax totals 7. 65% of your wages. If you are the employer, you will be making a 7.65% contribution.

  • State taxes and local taxes

The tax structure varies for every state. Some of them are simple, and others are complex. Some states charge a fixed tax for all sources of income. Some state tax structures have multiple tax brackets. And some states charge no tax at all.

Hence, we suggest you consult with your state governments or get virtual accounting firms' guidance to walk you through the procedure.

  • Federal income tax

The Federal income tax falls under seven brackets that range from deductions as low as 10% to a maximum deduction of 37%. These rates are applied progressively and are largely calculated on the details noted in Form W-4. The details include:

  • Single or married status filing separately.
  • Married couples filing jointly.
  • Whether the person is the head of the family.

Your federal taxes run the government machinery for public services such as military, education, and transportation.

  • Wage garnishments

Garnishments are deducted to cover an employee's unpaid debt. But it can also include alimony, child support, and defaulted loans taken by the employee. Your tax agency or the court will deduct the garnishments from any one of the following sources of income:

  • Monthly salary
  • Hourly salary
  • Commissions
  • Bonuses
  • Retirement plan payments
  • Pensions.

Voluntary tax deductions

All voluntary deductions require employee consent. Employers must get the written consent of the employees who opt for voluntarily deducting money from their salary, apart from keeping them well-informed. Additionally, employers are required to maintain accurate, up-to-date records of all voluntary tax deductions.

  • Group-term life insurance

Employers can make tax deductions if employees receive basic life-term insurance from their employers that cross $50,000. Funds can also be deducted on a post-tax basis if they want to buffer it with supplemental coverage or invest in life insurance.

  • Job-related expenditures.

Employees who belong to a union are likely to enjoy the tax benefits that the union offers. Payment for the union membership and benefits can be deducted from the salary. The deduction is made for other expenses such as uniform, travel, and food. Job-related deductions, however, are not permitted in all states.

  • Health insurance expenses

Offering health insurance is perceived as a strategy for employee retention. Health insurance deductions are based on the type of insurance plan the employer chooses. Health insurance deduction also includes doctor consultancies and prescriptions.

  • Retirement plans

If you've been offered any one of the popular retirement plans like 401(K) or the Individual Retirement Account(IRA), you ought to know what they hold in store for you. The 401(k) is subject to FICA tax, and the IRA contributions are withheld on a post-tax basis.

a person holding a tablet with hand-drawn details of payroll concepts

Guidelines from leading virtual accounting firms on how payroll deduction works

Payroll deductions are processed during every pay period. Gone are the days when the applicable taxes were manually calculated. Employers now depend on automated processes for accurate and timely filing of taxes. 

How do employers calculate how much to deduct for each employee?

Employers depend on the information given in the:

  • State and local withholding certificates
  • Form W-4 Employee's Withholding Certificate
  • Benefit selections
  • Health insurance plans
  • Garnishments ordered by the court.
  • Services performed in the job.
  • Place of business.

Where should you report your payroll deductions?

For first-timers, payroll deduction can seem like a tedious, complex process. The first stumbling block is mostly the confusion as to where the filings should be made.

All employee tax withholdings and employer tax payments are made using the following forms that can be manually filled out as paper forms or as e-files:

  • FUTA or Form 940: Employer's Annual Federal Unemployment Tax Return
  • Employer's quarterly federal tax return or Form 941
  • Employer's annual federal tax return or Form 944

Know about incorrect payroll deductions

As an employee, you must make yourself aware of incorrect payroll deductions. These deductions are often taken from the employee's salary when the employer has to be paying it themselves.

Here's where your employer can make incorrect deductions:

  • State employment tax
  • Worker's compensation insurance.
  • For PPE kits as per OSHA guidelines/
  • Work-related tools
  • Federal unemployment tax.

Track your taxes with Tickmarks, one of the best virtual accounting firms in the USA

Are you looking for professional guidance to handle your payroll and tax accounting? Tick Marks manages your online bookkeeping, payroll, taxes, and much more. To know how we can simplify things for you, give us a call! We’re here to help!

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