What are pre-tax deductions?

Pre-tax deductions examples

Is medical insurance a pre-tax deduction?

Yes, most employer-sponsored health insurance plans count as pre-tax deductions. These include but are not limited to major health insurance coverage, Health Savings Accounts (HSAs), Flexible Savings Accounts (FSAs), Section 125 cafeteria plans, and reimbursements for employer-sponsored health insurance premiums. Employees can typically find their health insurance-related deductions on their pay stubs.

Is dental insurance a pre-tax deduction?

Just like standard health insurance, dental insurance counts as a pre-tax deduction. It is subtracted from an employee’s gross pay before any taxes are withheld, reducing their taxable income.

Keep in mind that while the health insurance plans you offer to your employees can include dental and vision coverage, they don’t have to. Depending on your company, budget, and goals, you might want to look for a health insurance plan that comes with dental and vision policies or allows you to add them on later. Remember, that routine dental and vision care can keep your employees healthy and in turn, increase productivity.

Is life insurance a pre-tax deduction?

If your employees opt for voluntary life insurance premiums, they won’t count as pre-tax deductions. However, premiums for group-term life insurance coverage up to $50,000 may be considered pre-tax deductions and not part of an employees’ gross income. When group-term life insurance exceeds $50,000, the cost of the additional coverage is part of the employee’s gross income and therefore not a pre-tax deduction.

Note that if voluntary life insurance is available through a Section 125 cafeteria plan, employees may choose to pay for premiums on a pre-tax basis so they can reduce their taxable income by the premium amount paid for the voluntary life insurance policy.

Cafeteria plans and other pre-tax benefits

The term “pre-tax” is often linked with cafeteria plans, which are required to meet Section 125 of the Internal Revenue Code (IRC) to qualify as pre-tax.

Employers may also offer additional pre-tax benefits outside of cafeteria plans, as long as they comply with the respective IRC criteria. These can include:

• Commuter benefits (transit passes, parking, ride-sharing)
• Education assistance (tuition, fees, expenses for supplies)
• Health reimbursement accounts (traditional HRA, QSEHRA, ICHRA)

A note about retirement contributions

Tax-favored retirement plans, such as a traditional 401(k), are tax-deferred rather than pre-tax. This means that tax payments on contributions and earnings are postponed until the participant withdraws the funds. This deferral allows the employee to benefit from the “pre-tax effect,” effectively boosting their take-home pay.

Which taxes are pre-tax deductions exempt from?

Employers should not exclude all pre-tax deductions from all payroll taxes automatically. Instead, it’s important to determine which taxes are exempt for the benefit in question. From there, an employer deducts the benefit from the employee’s gross pay to arrive at their taxable wages and then withholds payroll taxes.

Tax implications of different pre-tax benefits

Most pre-tax benefits are exempt from federal income tax, Social Security tax, and Medicare tax withholding, plus federal unemployment (FUTA) tax. Social Security and Medicare taxes together are known as FICA taxes.

• Pre-tax deductions are typically exempt from state income tax withholding, though exceptions may exist. It’s advisable to consult with your state taxation agency for applicable rules. This exemption might also extend to other state and local payroll taxes, but it’s important to verify any exceptions.
• Group-term life insurance coverage exceeding $50,000 is subject to FICA taxes, but not federal income tax withholding or FUTA tax.
• Adoption assistance is subject to FICA taxes and FUTA tax, but not federal income tax withholding.
• If contributions to a pre-tax benefit exceed the legally prescribed limit, only the amount up to the limit is non-taxable. Any excess is considered taxable.

What pre-tax deductions are exempt from FICA?

As we touched on earlier, most pre-tax benefits are exempt from federal income tax, Social Security tax, and Medicare tax withholding in addition to federal unemployment (FUTA) tax. However, there are some exceptions. Adoption assistance, for example, is exempt from federal income tax but not Social Security, Medicare, and FUTA tax. In addition, pre-tax benefits might not be exempt from state and local taxes so it’s your responsibility as the employer to determine the laws in your area.

Reporting pre-tax deductions

Pre-tax deductions should not be included in an employee’s W-2 gross wages. However, employers may need to report certain details about pre-tax deductions in other areas of the W-2. A best practice is to provide a breakdown of pre-tax deductions on each pay stub, helping employees understand the calculation of their net pay. The final pay stub of the year should reconcile with the information on the employee’s W-2.

Do pre-tax deductions show on a W-2?

Yes, pre-tax deductions are reported on Box 1 of Form W-2. These may include employer-sponsored health insurance, dental insurance, disability insurance, life insurance, and 401(k) retirement plan contributions. Note that while these deductions may appear on a W-2, they might be excluded from your employees’ year-end pay stubs. Also, unless an employee opts out of pre-tax deduction, their salary will usually be higher than the wages that appear on the W-2.

Benefits of pre-tax benefits

• Pre-tax benefits are generally more cost-effective for employees than purchasing similar benefits independently using after-tax dollars, often due to employers obtaining lower group rates.
• These deductions put more money in the employee’s pocket on payday by reducing their taxable wages, which results in a higher net pay.
• Employers also benefit from tax savings, as they are not required to pay taxes on their contributions to these benefits.