You must know what to take from your employees’ paychecks in order to pay them correctly each pay week.
A small business owner’s employment requires him or her to pay personnel. You must not only pay your employees on time, but you must also ensure that you are paying them correctly. This means you’ll need a clear grip on the payroll deductions that should be taken out of each employee’s paycheck, such as taxes and benefit premiums. However, payroll deductions aren’t the most simple aspect of running a business, they are simpler than you would assume.
What are payroll deductions and how do they work?
Taxes, benefit payments, and wage garnishments are all examples of payroll deductions. They’re also known as paycheck deductions. You must withhold paycheck deductions for any workers to whom you intend to issue a W-2 form, but not for independent contractors or freelancers.
What is the difference between optional and mandatory payroll deductions?
When we talk about the tax reduction that comes with pretax deductions, another payroll tax factor comes to mind: Some payroll deductions are optional. Under the Affordable Care Act, some firms, such as those with 50 or more full-time employees (or the equivalent of part-time employees), must provide health insurance, but most small firms are not compelling to do so (and withhold wages for health insurance). However, there are two types of payroll deductions: voluntary and required payroll deductions.
- All benefit-related deductions include involuntary payroll deductions. However, voluntary payroll deductions include contributions to retirement plans and benefit premium payments.
- All payroll taxes and wage garnishments include mandatory payroll deductions. Therefore, payroll deductions for federal, state, and municipal income taxes, as well as FICA taxes, are all required.
- Before taxes are calculated, pretax deductions are subtracted from pay. Many retirement plans, like the 401(k), are tax-deferred. Similarly, Contributions to a 401(k) aren’t taxed, so they’re a great way to save money (at the time the contributions are made).
- After you’ve calculated your taxes, you’ll see post-tax deductions. Because post-tax deductions do not affect an employee’s total taxable income, there are no immediate tax benefits. Post-tax deductions include life insurance, charity contributions, and some retirement plans (such as a Roth IRA).
What are the different forms of payroll deductions?
However, payroll deductions are divided into seven categories:
1. Income taxes at the federal level
The federal government’s running expenses are paid for through federal income taxes. Therefore, the federal income tax withholding rate for each employee will vary; to determine this rate, utilize IRS Form W-4, which your employees should complete when they are recruited. One of two types of federal payroll taxes is this one.
2. Taxes on Medicare and Social Security (FICA taxes)
Employers are required to deduct Medicare and Social Security taxes from their employees’ paychecks under the Federal Insurance Contributions Act. In addition, FICA taxes are the second type of payroll taxes, and their rate is the same for all employees, albeit it varies each year.
To cover Social Security taxes, you will withhold 6.2 percent of each employee’s first $137,700 in salary in 2020. You’ll also deduct 1.45 percent of each employee’s salary for Medicare taxes, with no wage limitation.
Your company must pay FICA taxes from its business revenues as part of its employment taxes, which are separate from payroll taxes (unless your company is a pass-through entity). However, these taxes are levied at the same rates on your business’s income as they are on your employees’ earnings. Your FICA employer contributions, on the other hand, are totally tax-deductible, unlike your employee contributions.
3. Income taxes imposed by the state
These are state-level income taxes that are similar to federal income taxes. However, employee and state income tax withholding rates differ, and some states do not collect income tax at all. In addition, state income taxes, like their federal equivalents, are payroll taxes.
4. Income taxes in the locality
Individual municipalities or authorities in certain states collect local income taxes as well. Therefore, this payroll tax may be based on where you live or work, depending on your area. According to the Tax Foundation, only in 17 states, there is income tax collection.
5. Garnishments of wages
Wage garnishments are court-ordered payroll deductions that are used to cover an employee’s child support obligations or other legal responsibilities, such as debt. Similarly, if one of your employees obtains a writ of garnishment, you must recognize it within seven days. Therefore, within seven days of receiving the writ, you must begin withholding the appropriate cash.
Your employee, as well as you if you obtain a writ of garnishment for someone who isn’t one of your employees, can fight it. Similarly, you could be held liable for the debt of someone who does not work for your company if you refuse to acknowledge a writ of garnishment.
6. The cost of insurance premiums
When you offer health insurance as a perk to your employees, they are often responsible for a portion of the cost. However, these contributions deduct from each employee’s compensation. Payroll deductions can also be used to speed up your employees’ payments for their life insurance premiums.
7. Contributions to a pension
Employees might choose to have a percentage of their earnings withheld to contribute to their retirement plans if your company offers them. However, you can set up your payroll to transfer money into your employees’ retirement accounts, whether they have a 401(k) retirement plan or an individual retirement account (IRA).
8. Expenses related to your job
Employees pay specific expenses in specific jobs. However, work clothes, personal work phones, computers, and tablets are all examples of cost. This category typically includes union dues as well.
What is the procedure for reporting payroll deductions?
Mandatory payroll deductions must be reported on tax forms. You must record and pay FICA taxes on these payroll deductions using IRS Form 941. (though in rare cases, the IRS will instruct your company to use Form 944 instead). However, each state and municipal taxing authority will have its own set of required forms. Therefore, the procedure for reporting wage garnishments differs depending on the type of garnishment.
What do you mean by pre-tax deductions?
Pretax deductions are payroll deductions made before withholding payroll taxes from your employees’ gross salary. These deductions reduce taxable income for your employees, and because you must match the FICA taxes your employees pay on their earnings, pretax deductions can save your company money.
What exactly are erroneous payroll deductions?
This is a word used to describe situations in which a deduction is incorrect. It could be because too much money was held back, not enough money was held back, money was held back for the incorrect reason, or money that should have been held back was not.
Miscalculating compensation, having the improper categorization for an employee (particularly if some workers receive 1099), missing a deadline, and neglecting to update the company’s records are the most prevalent issues.
Is payroll tax a cost of doing business?
Employers are allowed to deduct their share of payroll taxes. Employees, on the other hand, are unable to do so.
What types of payroll deductions are tax-free?
There are several voluntary deductions that are tax-deductible. 401(k) and IRA retirement accounts are the most common. Pretax contributions are allowed in some health savings accounts, such as flexible spending accounts. In addition, Commuter benefits may be tax-free as well, but they are more limited.
What are the different forms of pre-tax deductions?
Because pretax deductions are mostly related to employee perks, you may be able to include the benefits you provide your employees among your tax deductions in some situations.
- Contributions to 401(k) and IRA plans: When you use payroll deductions to finance your employees’ retirement plans, you can claim the money as a tax deduction, lowering their taxable income.
- Parts of health and life insurance premiums paid out of pocket: Similarly, let’s imagine your firm doesn’t cover all of your employees’ benefit premiums and you rely on payroll deductions to make up the difference. You can deduct the remaining from your employees’ taxable income by adding it to your list of tax deductions.
- However, other benefit plan payments made on a monthly basis include: The cost of health and life insurance isn’t the only thing to consider. In addition, there are a variety of different premium-based benefits you can provide your employees, all of which can be deducted from their taxable income if they pay a portion out of pocket.
How to Work Out Your Payroll Deductions
You can use a payroll software package to automate your payroll deductions, or you can handle everything yourself. In addition, you’ll require the following information from each employee:
- W-4 form from the Internal Revenue Service
- Whether it’s an hourly wage or a yearly compensation, it’s important to
- The federal income tax withholding rate is a percentage of your gross income.
- Payment rates for additional benefits
Then follow these instructions:
1. Calculate your gross pay.
To begin, calculate your employee’s gross pay for the pay period using their income. Pay time and a half for any overtime hours worked, if appropriate.
2. Determine your pre-tax deductions.
Calculate all pretax deductions – benefit-related payments for the pay period – and remove them from the gross pay after you have your employee’s gross pay for the period. However, you’re now ready to figure out your statutory deductions.
3. Determine your federal income tax liability.
First, deduct federal income taxes using the information from your employee’s W-4 and the IRS Publication 15-T federal income tax withholding rates. Similarly, let’s have a look at an example: Assume your employee’s gross salary minus pretax deductions for a particular pay period is $3,000 each pay period. You calculate an 8 percent tax rate using your W-4 information and Publication 15-T, so multiply 0.08 by $3,000 to get a withheld sum of $240.
4. Work out your FICA taxes.
Calculate your employee’s FICA tax liabilities next. Multiply $3,000 by 6.2 percent for Social Security and 1.45 percent for Medicare to get $182 and $43.50, respectively, for the same employee.
5. Determine your federal, state, and municipal taxes.
Calculate your state and local tax liabilities now. Similarly, let’s say your state and municipal tax rates are 2% and 0.5 percent, respectively, for this example. You’d figure out $60 and $15 for each.
6. Determine the amount of wage garnishment.
Calculate wage garnishments for your employees using the court-ordered rate if necessary. However, if you were compelled to withhold 25% (a normal garnishment rate) for garnishments, you would multiply 0.25 by $3,000 to get $750.
7. Subtract all deductions from the wages of your employee.
As you’ve computed all of your deductions, subtract them from your employee’s gross compensation for the time period. Then reduce your voluntary deductions – it’s easy to overlook these deductions because you used them to figure out your employee’s taxable income.
How to Make Payroll Deductions Easier
If you’re concerned about making mistakes while calculating your payroll deductions, don’t worry; you can calculate and pay your payroll taxes in different methods. Similarly, you can set up automated payroll approval and deduction for your firm by registering with a payroll software provider. And in conclusion, do check out our guide to the best payroll software platforms to find the appropriate fit for your company, streamline payroll deductions and payments, and guarantee you’re in compliance with all applicable tax rules.