Most employees can elect to have pre-tax payroll deductions taken out of each paycheck. Pre-tax payroll deductions are expenses deducted from your gross pay rather than your net pay. This gives you the opportunity to pay for medical, health and even child care expenses on a pre-tax basis. Only certain plans and expenses can be deducted pre-tax, and those expenses can't be deducted a second time on your tax return.
What Pre-Tax Deductions Are
When you receive your paycheck, the take-home pay you receive is net of federal, state and Medicare taxes. Your gross pay is the amount on your check before those taxes are calculated and deducted. A pre-tax deduction is an amount deducted from your gross pay rather than your net pay. Pre-tax deductions appear as line items on your paycheck and can often be changed only during your employer's open enrollment period.
What's Eligible For Pre-Tax Deductions
The Internal Revenue Service governs what types of deductions can be deducted pre-tax. You also may be limited in pre-tax deductions based on what insurance plans your employer offers. Medical, dental, vision and long-term disability insurance premiums may be deducted either post-tax or pre-tax. Parking permits, flexible spending accounts, dependent care plans and health savings accounts may also be deducted on a pre-tax basis. Personal accident insurance, voluntary life insurance, short-term disability and charitable contributions may be deducted only on a post-tax basis.
What the Benefits of Pre-Tax Deductions Are
The biggest benefit of pre-tax payroll deductions, other than convenience, is that they reduce your taxable income. Say for example that your gross income is $5,000 a month. If you take $200 in pre-tax payroll deductions, you'll pay taxes on only $4,800. Because of the wide range of health-related expenses you can pay for with flexible spending accounts and health savings accounts, this means that you can pay for medications, copayments and even child care with pre-tax dollars.
How to Deduct Pre-Tax Expenses
Many of the expenses you pay for with pre-tax deductions could potentially be deductible on your annual tax return. For example, the IRS allows taxpayers to deduct medical expenses that exceed 10 percent of the taxpayer's adjusted gross income. Child care expenses are also normally deductible. It's important to know that you cannot claim a tax deduction for any expenses you paid with pre-tax deduction dollars. If you did, you would essentially be receiving two tax deductions. Still, pre-tax payroll deductions tend to be a better deal because you aren't limited to IRS deduction ceilings, floors or income limitations.
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