Payroll Deductions

What Are Payroll Deductions?

Payroll deductions are the amounts withheld from an employee’s paycheck for specific purposes, such as paying federal, state, and local taxes or contributing to benefits. These deductions help ensure that legal obligations like federal and state income taxes are met, while also helping employees access valuable benefits such as health insurance, retirement savings, or flexible spending accounts.

Payroll deductions determine how much of an employee’s gross pay, the total amount earned before any deductions, becomes take-home pay, also known as net pay.

Employers are responsible for calculating, withholding, and submitting these amounts accurately. Done correctly, deductions help businesses and employees comply with tax laws.

Types of Payroll Deductions

There are two main types of payroll deductions: mandatory and voluntary.  

Mandatory deductions are required by law and cover things like employee tax deductions. Voluntary deductions are chosen by the employee and often include benefits such as health insurance or retirement contributions.

If an employee earned $1,500 in gross pay, mandatory employee-only deductions—such as federal income tax, state income tax, and local income tax—would be withheld based on their filing status and location.  

For example, if the total taxes and withholdings totaled $300, their take-home pay would be $1,200. To see an estimated breakdown of how this works, check out our payroll deduction calculator.  

Mandatory Payroll Deductions

Examples of mandatory payroll deductions, also known as statutory deductions, can include:

• Federal income tax: Federal income tax is the amount the federal government requires employers to withhold from employee paychecks based on earnings, filing status, and allowances. It applies to most forms of income, including salaries, bonuses, and tips. Workers with very low earnings or certain exemptions may not be required to pay federal income tax. This amount is determined based on how employees complete their Form W-4, Employers Withholding Certificate.  

• Social Security and Medicare (FICA): Social Security and Medicare taxes are required payroll deductions under the Federal Insurance Contributions Act (FICA). Employers must withhold a portion of each employee’s wages to fund these programs, which provide retirement, disability, and health benefits. Employers contribute an equal amount.

• State and local income taxes (where applicable): State income tax requirements vary across the U.S. Some states charge a flat rate on all income, others use multiple tax brackets, and a few don’t levy any income tax at all. Because rules differ, and some states follow the federal tax code, it’s important for employers to stay up to date on each state’s regulations to ensure full compliance.

• Wage garnishments (court-ordered deductions): Wage garnishment is a legal process that requires employers to withhold part of an employee’s earnings to repay debts such as taxes, child support, or court-ordered judgments. The employer sends the withheld amount directly to the agency or creditor until the debt is paid off.

Employers may face fines or penalties if they fail to withhold mandatory payroll deductions correctly.

Voluntary Payroll Deductions

Voluntary payroll deductions examples include:

• Retirement savings contributions (401(k), etc.): Retirement savings plan contributions allow employees to set aside part of their earnings for future financial security through plans such as a 401(k). Employers deduct these contributions directly from paychecks, and depending on the plan type, the contributions may be made before or after taxes.

• Health, dental, and vision insurance: Health, dental, and vision insurance premiums are voluntary deductions that can help employees access medical plans and care. Employers can deduct premium contributions directly from employee paychecks, often on a pre-tax basis, which reduces employees' taxable income.

• Life insurance: Depending on the plan, life insurance deductions may be taken on a pre-tax or post-tax basis.

• Flexible spending accounts (FSAs): An FSA lets employees set aside money to cover eligible healthcare or dependent-care expenses. Employers deduct these pre-tax contributions from paychecks before taxes are calculated, lowering taxable income.

• Union dues: Union dues are voluntary deductions that cover membership costs for employees represented by a labor union. These funds support collective bargaining, contract negotiations, and other activities that benefit union members.

• Charitable contributions: Some employers allow workers to donate to approved charities directly through payroll deduction. This convenient option lets employees spread out donations across multiple pay periods to support causes they care about throughout the year.

Voluntary payroll deductions may require employees' written consent before being withheld from their paychecks.

Payroll Deduction Abbreviations

Payroll deductions often appear on pay stubs as abbreviations, each representing a specific tax or insurance required by federal, state, or local law. Some deductions are withheld only from employee pay, some are paid solely by employers, and others are shared between both parties. Understanding these codes can help with understanding compliance and transparency.

Common abbreviations include:  

• FED: Federal income tax withheld, as required by the IRS. (Employee)

• FICA: Federal Insurance Contributions Act tax, which includes Social Security and Medicare taxes. (Employee and employer)

• LOCAL: Local income tax withheld, if applicable in your city or municipality. (Employee)

• MED: Medicare tax, part of FICA, funds federal health insurance for people 65 and older. (Employee and employer)

• SUI: State Unemployment Insurance tax, which funds unemployment benefits. (Employer only in most states)

• SDI: State Disability Insurance tax, withheld in certain states to provide disability benefits. (Employee only in applicable states)

• SS: Social Security tax, part of FICA, funds retirement and disability benefits. (Employee and employer)

• STATE: State income tax withheld, as required by your state’s tax authority. (Employee)

• WKC: Workers’ Compensation Insurance, which provides benefits for job-related injuries or illnesses. (Requirements vary by state, typically paid by employer.)  

Pre-Tax vs. Post-Tax Deductions

Not all payroll deductions affect take-home pay in the same way. Some are deducted before taxes are calculated, reducing taxable income, while others are withheld after.  

Understanding the difference between pre-tax and post-tax deductions can help employers process payroll accurately and allow employees to make the most of their benefits.  

Let’s take a closer look at how each one works.

What Are Pre-Tax Deductions?

Pre-tax deductions are amounts taken from an employee’s paycheck, or gross pay, before federal, state, and sometimes local taxes are calculated. Because they lower an employee’s taxable income, they can reduce the total amount of taxes owed.  

Common pre-tax deductions examples include contributions to retirement plans like 401(k)s, health and dental insurance premiums, and flexible spending or health savings accounts.

Employers can also benefit from the various types of pre-tax deductions. They can simplify benefits administration and can help lower payroll taxes since the taxable wage base is reduced.

What Are Post-Tax Deductions?

Post-tax deductions are amounts withheld from an employee’s paycheck after taxes have been calculated and withheld. Because these deductions don’t reduce taxable income, they don’t offer an immediate tax benefit. Common examples of post-tax payroll deductions can include Roth IRAs, disability insurance premiums, union dues, and wage garnishments.

The key difference between pre-tax and post-tax deductions lies in when they’re taken from pay and how they affect taxable income. Here’s a simple comparison.

How to Calculate Payroll Deductions

Payroll deductions are processed each pay period based on applicable tax laws and withholding information provided by employees or court orders.  

Employers can calculate deductions manually or automate the process with a payroll service. Many small businesses prefer automation because it helps minimize mistakes and can help manage payments to tax agencies and benefit providers.

The amount withheld for each employee depends on several factors, including their Form W-4, state and local withholding certificates, and benefit selections. For example, deductions may vary depending on whether an employee participates in a health insurance plan or is subject to a court-ordered garnishment.

Your company’s location and where employees perform their work also affect payroll deductions, since not every state imposes an income tax.

If uncertain about how payroll deductions work, you’re not alone. The good news is that once you understand the order of each step, calculating gets a little easier.  

1. Determine gross pay. Start with the employee’s total earnings for the pay period, including hourly wages, salary, bonuses, or commissions. Learn more about the difference between gross pay and net pay in this post.

2. Subtract any pre-tax deductions such as health insurance premiums, FSA or HSA contributions, and 401(k) plan contributions. These reduce the employee’s taxable income.

3. Calculate and withhold mandatory taxes. Use the employee’s Form W-4 information to calculate federal income tax withholding.

Then apply FICA taxes: 6.2% for Social Security tax (up to the annual wage limit) and 1.45% for Medicare. If an employee’s year-to-date earnings exceed $200,000, withhold an additional 0.9% for the additional Medicare tax.

Don’t forget to include state and local income taxes where applicable.

4. Apply post-tax deductions. Subtract any remaining deductions, such as Roth 401(k) contributions, wage garnishments, or union dues.

5. Calculate net pay. The remaining amount after all deductions is the employee’s net pay: the amount you deposit into their account.

Payroll deductions involve a lot of moving parts, but a few smart habits can help make the process easier and more reliable:

• Double-check deduction rates and contribution limits each year, since tax laws and benefit thresholds often change.

• Keep employee records current, including W-4 and benefits selections.

• Verify that both employer and employee portions of FICA taxes are being calculated correctly.

Payroll software or services like SurePayroll® By Paychex can help automate these steps, helping employers save time and money.  

Penalties and Liabilities

Employers are legally responsible for accurately calculating, withholding, and depositing payroll deductions such as federal and state income taxes, Social Security, and Medicare. Failure to do so can result in significant IRS penalties, including the Trust Fund Recovery Penalty, which may equal 100% of the unpaid tax if withholdings are not properly forwarded to the IRS. In addition to fines, employers may also owe interest on any unlawfully retained amounts.

Mistakes in payroll deductions can also lead to employee dissatisfaction and compliance issues at the state or federal level. To help avoid these risks, many businesses use automated payroll services like SurePayroll to help streamline calculations and ensure timely payments to tax agencies and benefit providers.

SurePayroll Can Help Calculate Payroll Deductions

Managing payroll processing and payroll deductions can get complicated, especially when you’re juggling different benefit plans, tax rules, and employee updates. SurePayroll can help take the guesswork out of the process by automatically calculating, withholding, and submitting deductions for you.

Plus, employees can easily review their pay stubs and deductions anytime, giving everyone peace of mind that payroll is accurate and transparent.

By simplifying deduction management, SurePayroll can help business owners save valuable time so they can focus on what really matters: running and growing their business.