Payroll deductions come in many forms. Each one falls into one of two categories: mandatory or voluntary. Mandatory deductions are required by the federal, state or local government. Voluntary deductions are not legally required and are offered at the employer’s discretion. The laws governing payroll withholding vary by deduction type.
Under federal law, employers must withhold federal income tax and Social Security and Medicare taxes from employees’ paychecks. Most states require that employers perform state income tax withholding as well. A few states mandate state unemployment tax and state disability insurance withholding. Some local governments impose local, county or city income tax on employees who live or work in the area.
Voluntary deductions include medical, dental, vision, life and disability insurance; retirement plan contributions; flexible spending account; dependent care; adoption assistance; health savings account; transit and parking; tuition and charitable contributions. Though an employer does not have to offer these benefits, the federal or state government may have rules affecting how they should be established and deducted. For example, in some states, employers offering health insurance must do so under a cafeteria plan, which is regulated by the Internal Revenue Service. Union dues are a voluntary deduction -- or a mandatory one, in the case of a closed shop -- that's regulated by the collective bargaining agreement. Voluntary benefits provided on a pretax basis are excluded from certain taxes; the employer subtracts the benefit from the employee’s gross wages before deducting the tax, resulting in tax savings.
Federal Tax Withholding Rules
An employer can find all, or most, of the information it needs on federal payroll tax withholding in IRS Circular E, the Employer’s Tax Guide. The publication includes rules on Form W-4 and information about how to use the form and the enclosed withholding tax tables to calculate federal income tax withholding. Circular E also contains flat withholding rates for Social Security and Medicare taxes.
State Tax Withholding Guidelines
State tax withholding rules are administrated by the state revenue agency. For example, as of the publication date, employers in Pennsylvania must withhold state income tax at 3.07 percent. In most states, employers must use either the employees’ state withholding form or Form W-4 and the state tax withholding tables instead of a flat percentage. If local taxes apply, such as Ohio’s school district tax or Michigan’s city income tax, withholding procedures are usually listed on the local tax assessor or state revenue agency website.
A wage garnishment is a court- or government-ordered document instructing an employer to withhold from an employee’s wages to satisfy a debt. Title III of the Consumer Credit Protection Act is the federal law that restricts the amount an employer can withhold for an ordinary wage garnishment. Some states have their own wage garnishment limits, which may differ from federal law.
Submitting Payroll Deductions
Employers must submit mandatory deductions to the appropriate government agency by the agency's deadline. Federal income tax and Social Security and Medicare taxes are typically submitted to the IRS every month or every two weeks. IRS Circular E explains the payment schedule. Most employers must report federal tax withholding plus their own portion of Social Security and Medicare taxes to the IRS quarterly on Form 941. If authorized by the IRS, small employers with annual tax liability of $1,000 or less can report and pay their tax liability on a yearly basis.