Payroll Deduction Regulations
Payroll deduction regulations depend on whether the deduction is statutory or voluntary and the deduction type. State law may dictate what constitutes an illegal deduction. The state of California, for example, recognizes deductions for uniforms, gratuities, bonds and business expenses as unlawful. Consequently, the employer should ensure that it makes payroll deductions appropriately.
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Types
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The Internal Revenue Service requires employers to withhold federal payroll taxes, such as federal income tax, Medicare tax and Social Security tax from employees' paychecks. Most state revenue agencies require employers to withhold state income tax, and in some cases, city and local income tax, from employees' paychecks. These taxes are statutory deductions that employers must withhold. Notably, a wage garnishment is a statutory deduction.
Voluntary deductions are those that exist under an established company policy, which the employee consents to. Voluntary deductions include health and retirement plans, parking fees, paycheck advance and charitable contributions. The employer can also deduct the employee for overuse of benefit days, such as vacation and sick days and overpayment of wages.
Calculations
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The employer uses the employee's W-4 form (specifically, her filing status and allowances) and the IRS Circular E's withholding tax tables to calculate federal income tax. It computes Social Security tax at 6.2 percent of gross income, up to the yearly wage maximum of $106,800; and Medicare tax at 1.45 percent of all gross income. It uses its state revenue agency's guidelines to calculate state, city and local income tax. Most states require the employer use the employee's state withholding tax form, similar to her W-4 form, and the state withholding tax tables to figure state income tax. The employer calculates wage garnishments according to the garnishment notice's instructions. The employer cannot withhold more than 25 percent of an employee's disposable income for a wage garnishment in one pay period.
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Pretax and Post-tax
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Voluntary deductions occur on a pretax or post-tax (after-tax) basis. The deduction is pretax if it meets the criteria of IRS Section 125 code, which allows employees to pay for the deduction in pretax dollars. The employer deducts the pretax benefit before withholding taxes, thereby lowering the employee's taxable income. Common pretax deductions include traditional 401(k) plans, Section 125 medical and dental plans, and flexible spending accounts, such as childcare expenses. A deduction is after-tax if it is not pretax. This means that the deduction is made after tax withholding.
Considerations
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The employer pays federal payroll taxes to the IRS, typically semiweekly or monthly. It reports federal income tax, Medicare tax and Social Security tax liabilities to the IRS, typically quarterly or annually. IRS Circular E is a valuable tool for employers; it provides compliance regulations for tax withholding, payment and filing. The state revenue agency can give the employer all the information it needs on complying with state deduction laws.
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References
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