What are payroll deductions?

A payroll deduction is any amount that an employer subtracts from an employee's gross wages. These deductions can be categorised into mandatory and voluntary deductions. Mandatory deductions are required by law, while voluntary deductions are elected by the employee or offered by the employer as part of a benefits package.

Determining payroll deductions

To determine payroll deductions for your employees, follow these steps:

1. Calculate gross pay

Determine the employee's total earnings before any deductions, including pay, wages, bonuses, and overtime.

2. Apply mandatory deductions

Apply the mandatory deductions based on the employee’s location. For example, if your employee is based in the US, you would need to deduct:

Federal income tax
Any required state and local taxes
Social Security and Medicare (FICA)
Unemployment insurance

3. Apply voluntary deductions

Apply any voluntary deductions for supplemental benefits and other costs, such as:

Retirement contributions
Health insurance premiums
Life and disability insurance

4. Calculate the net pay

Subtract all mandatory and voluntary deductions from the gross pay to determine the employee's net pay.

Payroll deduction examples

In the US, a typical payroll deduction might look something like this:

Mandatory deductions:

Federal income tax: A portion of earnings withheld based on IRS tax brackets (e.g., 20%).
State income tax: Depending on the state, an amount withheld for state taxes (e.g., 5%).
Social Security: Withheld at 6.2% of earnings up to a certain limit.
Medicare: Withheld at 1.45% of all earnings.

Voluntary deductions:

401(k) contributions: Employee contributions to a retirement savings plan, often matched by the employer up to a certain percentage.
Health insurance premiums: Payments for employer-sponsored health insurance plans.
Union dues: Fees paid by employees who are members of a labour union.
Charitable donations: Employee-elected contributions to charitable organisations.

Key considerations

When carrying out payroll deductions, always ensure that you are:

Accurate. Ensure accurate calculations of deductions to avoid errors and discrepancies in employee paychecks.
Communicative. Clearly communicate the types and amounts of deductions to employees, including any changes in rates or contributions.

Compliant. Stay informed about changes in tax laws and regulations to maintain compliance and avoid penalties.

Payroll deductions