Deduction meaning: What is a deduction?

More about paycheck deductions

Employers pay many expenses on behalf of employees. For example, employers who offer retirement plans are responsible for collecting employees’ contributions and remitting them to the plan provider.

 

To calculate an employee’s paycheck, an employer begins with the gross pay (total wages) an employee earns. Next, the employer determines the net wages on the employee’s paycheck by subtracting any withholding of payroll taxes, as well as the deductions for any other expenses or obligations of the employee.

 

 

While paycheck deductions are usually voluntary, garnishments and levies are examples of involuntary deductions that can be subtracted from employees’ earnings and paid to a third -party in response to a court order.

 

Note: While payroll taxes are technically “deducted” from an employee’s net wages, the term “withholding” is typically used for such involuntary transactions.

Required vs. voluntary deductions

Understanding how deductions work starts with knowing what you have to withhold, rather than what your employees choose to have withheld. Employers send the money deducted for taxes to the federal and state governments to pay for public goods and services.

• Statutory (or mandatory): Required withholdings that include federal and state income taxes, as well as FICA payroll taxes. FICA taxes consist of a 6.2% Social Security tax and a 1.45% Medicare tax.
• Voluntary: These are optional withholdings that employees ask to have withheld. Examples include contributions to retirement accounts and employer-sponsored health benefits.

Pre-tax vs. post-tax deductions: What’s the difference?

When dealing with voluntary benefits, the timing of the deduction determines how it affects an employee’s taxes.

Pre-tax deduction examples

Pre-tax deductions get subtracted directly from a person’s gross income before any taxes are calculated. Because these deductions reduce an employee’s gross income, they reduce the total amount of earnings the worker has to pay taxes on.

• Examples include: Group health, dental, and vision insurance (Section 125 Cafeteria Plans), Traditional 401(k) contributions, and Flexible Spending Accounts (FSAs).

 

Post-tax (after-tax) deduction examples

Post-tax deductions get taken out of an employee’s paycheck after all payroll and income taxes have already been accounted for and withheld. These do do not lower the employee’s taxable income.

• Examples include: Roth 401(k) contributions, union dues, charitable contributions, and involuntary wage garnishments (such as child support or unpaid taxes).

We also put a table below to help you see the differences at a glance.

 

Reference table: Deductions to know

 

Category	Definition	Types	Tax impact
Required/statutory	Taxes legally required by the government.	Include FICA, Federal/State Income Tax	Calculated based on employees’ gross or taxable income
Pre-Tax	Subtracted from gross income before taxes.	Health insurance, Traditional 401(k)	Reduces taxable income
Post-Tax	Subtracted after taxes are applied.	Roth 401(k), Union dues	No impact
Involuntary	Court-ordered or legally binding withholdings.	Wage garnishments, Child support	No impact