What Is the Meaning of Payroll Deductions?
Payroll deductions refer to the statutory and voluntary deductions employers withhold from employees' paychecks. Statutory deductions are those that a legal entity requires; voluntary deductions are those the employer offers and the employee accepts. Each payroll deduction has its own processing criteria.
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Identification
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Statutory deductions are also called involuntary deductions. They include federal income tax, state income tax, Social Security tax, Medicare tax, IRS wage levies, wage garnishments and child support withholding orders. Voluntary deductions include company-sponsored benefits, such as retirement and health plans, parking fees, union dues, employee donations and life insurance.
Significance
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Federal income tax funds national programs, including law enforcement, defense, foreign affairs and community development. State income tax funds state programs, including public health and schools and correctional facilities. Social Security tax provides benefits to the disabled, retirees and their dependents. Medicare tax provides health insurance coverage to workers, retirees and their spouses when they reach age 65.
Creditors and the courts use wage garnishments and child support orders as a way of getting debtors and parents to uphold their financial obligations. Employers provide voluntary deductions as a benefit to their employees. Having certain deductions, such as donations and union dues, deducted from wages is more convenient than if the employee were to deduct and pay the item herself.
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Statutory Calculations
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The employer uses the worker's W-4 form and the IRS withholding tax tables, also called IRS Circular E, to withhold federal income tax. It withholds state income, if applicable, based on the state's standards. In most cases, it uses the state withholding tax table and the employee's state income tax withholding form to figure the tax. It withholds up to 50 or 60 percent for child support, and can deduct an extra 5 percent for support payments over 12 weeks behind. The employer cannot deduct more than 25 percent of disposable income for a wage garnishment. It uses IRS Publication 1494 to figure the amount of income exempt from an IRS wage levy.
Pretax vs. Post-tax
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A voluntary deduction falls into two categories: pretax and post-tax. Pretax means the deduction meets the requirements of IRS Section 125, and is withheld from wages before payroll taxes. This process reduces the employee's taxable earnings, resulting in a tax break. Most medical, dental and 401k plans are pretax. If the deduction is not pretax, it's post-tax; this type of deduction is made after taxes are withheld, and therefore, do not reduce taxable income. Examples of post-tax deductions include Roth 401k and charitable contributions. Calculations for voluntary deductions vary by employer.
Considerations
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The employer pays federal payroll withholding to the Internal Revenue Service, and state payroll tax withholding to the state revenue agency. It pays wage garnishments and child support withholding to the issuing institution, and voluntary deductions to the respective company. For example, it pays 401k contributions to the plan provider.
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