After-tax deductions definition and meaning
After-tax deductions are amounts taken out of an employee’s wages after applicable pre-tax deductions and payroll taxes have been withheld. These deductions may be voluntary, such as Roth 401(k) contributions, or involuntary, such as wage garnishments.
More about after-tax deductions
Also called “post-tax deductions,” after-tax deductions should not be confused with pre-tax deductions – which are withheld from wages before deducting payroll taxes. As stated, after-tax deductions come out of gross pay after taking taxes out.
Here’s the formula for both:
- Gross Pay – Pre-tax Deductions (if applicable) – Payroll Taxes – After-Tax Deductions = Net Pay
Because you subtract after-tax deductions after withholding payroll taxes, they do not reduce the employee’s taxable wages – which is the amount of pay that is subject to taxation. As a result, after-tax deductions do not increase take-home pay.
Conversely, you subtract pre-tax deductions before withholding payroll taxes, thereby reducing the employee’s taxable wages – which, in turn, increases their net pay.
Examples of after-tax deductions
- Roth 401(k) contributions, or any other type of retirement contribution that is not pre-tax
- Group-term life insurance exceeding $50,000 worth of coverage
- Union dues
- Disability insurance
- Charitable contributions
- 529 college savings plan contributions
- Wage garnishments, such as for medical bills, credit card debt, student loans, unpaid taxes, and child support
A note about voluntary benefits
Voluntary benefits – like health insurance, flexible spending accounts, and commuter benefits – are oftentimes pre-tax rather than after-tax. Typically, such benefits are offered to employees on a pre-tax basis, as long as they meet the requirements of the respective Internal Revenue Code (IRC).
For further details on pre-tax benefits, refer to our guide ‘What are pre-tax deductions?’
What makes a voluntary benefit after-tax?
- If a voluntary benefit does not qualify as pre-tax, then it is after-tax. For example, if your health insurance plan does not meet the IRC criteria for pre-tax status, you can still offer it – but as a taxable benefit. Here, you would subtract the employee’s health insurance premiums after withholding payroll taxes from their gross pay.
- If the contributions for the voluntary benefit exceed the legally prescribed limit for the year, then the excess amount is taxable (after-tax). For instance, you must take payroll taxes out of excess contributions made to a dependent care flexible spending account.
Which taxes should you withhold from after-tax deductions?
These deductions are subject to withholding for:
- Federal income tax
- Social Security tax
- Medicare tax
- State income tax (if applicable)
- Local income tax (if applicable)
- Any additional state or local payroll taxes (e.g., state unemployment tax, state disability insurance tax, etc.)
Tax savings: After-tax versus pre-tax benefits
While pre-tax benefits may seem to have the edge in terms of tax savings, this isn’t always the case.
Many pre-tax benefits are nontaxable, which means the employee doesn’t owe taxes on the benefit at the time of payroll withholding or afterwards. However, some benefits are treated as pre-tax, but the employee will owe income taxes at a later date.
For example, an employee won’t pay income taxes on their contributions to a traditional 401(k) plan until they withdraw the funds in the future. But if they had a Roth 401(k) instead, they would pay income taxes on their contributions upfront — at the time of payroll withholding. In this case, when they later withdraw the funds, they will not owe income taxes on their contributions.
This Roth (after-tax) option may work out in the employee’s favor, as they won’t have to worry about paying income taxes on their future withdrawals – which can be especially advantageous if the income tax rate is higher at that time.
Reporting after-tax deductions on Form W-2
For example, you would include amounts deducted for a wage garnishment in Box 1, which represents total taxable wages for federal income tax purposes. You would also include the garnishment amounts in the Social Security tax, Medicare tax, and applicable state and local taxable-wage boxes.
Keep in mind, these boxes do not reflect pre-tax deductions that are exempt from these taxes.
Claiming tax deductions for after-tax benefits
Individuals who paid for certain benefits on an after-tax basis may be able to reduce their taxable income at tax time by claiming a deduction.
For example, they may be able to claim a deduction for amounts paid to a traditional IRA and for unreimbursed medical and dental expenses.
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