What are pre-tax deductions? A guide for US employers

In payroll, understanding the difference between pre-tax and post-tax deductions is crucial. Pre-tax deductions are a key element that can help reduce taxable income, allowing both employers and employees to benefit.

In this article, we’ll walk you through what pre-tax deductions are, the main types commonly seen in the US, how they affect employee take-home pay, and why offering pre-tax benefits can be a game-changer for your business.

We'll also show you how the right tool can simplify this process, making managing pre-tax deductions a breeze.

What are pre-tax deductions?

Pre-tax deductions are the amounts subtracted from an employee’s gross pay before taxes are calculated. These deductions reduce the employee’s taxable income, which means they pay less in federal income taxes, state income taxes, and often, other payroll taxes like Social Security and Medicare.

How do pre-tax deductions benefit employers?

Pre-tax deductions can benefit your organization in the following ways:

• Lower taxable wages. When employees have pre-tax deductions, their taxable income decreases, reducing your tax liabilities for Social Security, Medicare, and Federal Unemployment Tax (FUTA).

• Increased employee satisfaction: Offering pre-tax benefits like health insurance and retirement plans can improve recruitment and retention, demonstrating your company’s commitment to employee well-being.

Common types of pre-tax deductions in the US

Here are some of the most common pre-tax deductions that employers can offer:

Health insurance premiums

Employee contributions to health, dental, and vision insurance plans are typically pre-tax. These are deducted before federal and state income taxes are calculated, lowering both employer and employee tax liabilities.

Retirement plans (401(k) and 403(b))

Contributions to qualified retirement plans, such as 401(k) or 403(b), are another example. Employees can allocate a portion of their income towards retirement savings, reducing their taxable income in the process.

Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs)

Contributions to HSAs and FSAs are pre-tax as well. These accounts allow employees to set aside money for qualified medical expenses and dependent care costs, all while reducing their taxable income.

Commuter benefits

Pre-tax commuter benefits cover eligible transportation expenses like transit passes or parking fees. This is a great way to help employees reduce commuting costs while also cutting down on their taxable income.

How do pre-tax deductions affect payroll?

Pre-tax deductions directly impact an employee’s take-home pay by lowering their gross taxable wages. This reduction means that less income is subject to federal, state, and sometimes local taxes, resulting in an overall higher net pay for employees.

For example, say that one of your employees earns $5,000 per month. They contribute $200 to a 401(k) and pay $300 for health insurance, both of which are pre-tax deductions. Instead of being taxed on the full $5,000, they’ll be taxed on $4,500. This results in less income being withheld for taxes, leaving more in their paycheck.

Compliance considerations for employers

While pre-tax deductions offer several benefits, they also come with legal and compliance responsibilities. It’s critical that you:

• Adhere to Internal Revenue Service (IRS) regulations. Make sure that the deductions you offer qualify under IRS rules for tax-exempt status.

• Stay updated on limits. Contribution limits for retirement plans, HSAs, and other benefits change periodically, so it’s important to stay current with these figures.

• Communicate with employees. Clearly explain how pre-tax deductions work and what the benefits are to avoid confusion or mismanagement of payroll.

Remote can help you do this. Our platform automates payroll processing, ensuring that pre-tax deductions like health insurance premiums and retirement contributions are accurately calculated and withheld. This is frequently updated to ensure full compliance with all relevant federal, state, and local laws, giving you peace of mind and allowing you to focus your resources and attention elsewhere.

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Attracting and retaining talent in today’s competitive job market is about more than just offering a paycheck. Pre-tax benefits, such as health insurance and retirement plans, can make a significant difference in your total compensation package, giving you an edge in recruitment while also helping employees reduce their taxable income.

To learn more about how Remote Payroll can automate your payroll and ensure full compliance with all relevant laws, speak to one of our friendly experts today.

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