Calculating payroll deductions may not be the most thrilling aspect of running a company, but it’s an important and unavoidable part of the payroll process for most employers. As a business owner, it’s up to you to ensure that taxes and other dues are taken out of employees’ paychecks each pay period.
Navigating tax laws might be complicated, but finding the right office space for your company shouldn’t be. WeWork designs flexible workplace solutions to suit every kind of business, providing collaborative spaces of all sizes and in locations around the world.
For even more flexibility, WeWork All Access and WeWork On Demand let you access workspaces and meeting rooms in hundreds of locations across multiple cities, allowing teams to do their best work wherever they are.
In this article, we’ll take a closer look at payroll deductions, including what they are, why they’re important, and how employers can calculate them accurately.
What are payroll deductions?
Payroll deductions are amounts of money taken out of an employee’s paycheck each month by their employer. These deductions go toward expenses like Social Security and Medicare taxes, wage garnishments, 401(k) contributions, and other benefits, like medical insurance.
The amount of money in a paycheck before payroll deductions is known as gross pay, while the amount left over is known as net pay—that’s typically the amount that appears in the employee’s bank account when they’re paid.
Payroll deductions are made either before or after tax has been calculated. Participating in things like voluntary retirement plans, for example, can be highly tax efficient, as employees don’t pay income tax on the portion of their earnings they put toward retirement.
Why it’s important to deduct taxes from paychecks
Withholding a portion of an employee’s paycheck to cover employment-related taxes is a legal requirement in the United States. Employers who fail to make these important payroll deductions can be asked to make up the shortfall by paying the missing amounts.
While full-time employees must have some of their salary withheld, employers typically aren’t required to withhold any income tax for their independent contractors. It’s important to understand the differences between full-time employees, statutory employees, and freelancers when it comes to tax matters.
What percentage of a paycheck is withheld for federal tax?
When making payroll deductions, there are two main types of federal tax to consider.
The first is FICA taxes, which are payroll taxes used to fund Social Security and Medicare. They comprise 7.65% of the employee’s gross pay (6.20% for Social Security and 1.45% for Medicare), which the employer must match for a total contribution of 15.30%.
There are a few more specific rules for employees who earn more than the Social Security Wage Base, or who earn enough to be subject to Additional Medicare tax.
The second type is federal income tax, which is an amount of money withheld from an employee’s paycheck based on their filing status and how much they earn in a year. The seven federal tax brackets range from 10% to 37%.
An employee can use the IRS withholding calculator to determine how much federal tax will be withheld from their paycheck.
Pre-tax vs. post-tax vs. voluntary deductions
Payroll deductions can be categorized into three main types: pre-tax, post-tax, and voluntary.
- Pre-tax deductions are taken out of an employee’s paycheck before taxes are calculated. This usually includes contributions to 401(k)s, health savings accounts, and other retirement accounts.
- Post-tax deductions are taken out after all federal and local taxes have been calculated. These include things like union dues, child support payments, life insurance payments, and other benefits.
- Voluntary deductions are amounts that an employee chooses to have taken out of their paycheck, such as charitable donations or loan repayments.
How to calculate and deduct taxes from a paycheck, step-by-step
Payroll deductions must be handled with care, as there are legal consequences for failing to make timely payments. Employers must also ensure that employees are fully informed of all deductions that are being taken out of their paychecks.
The following is a rough guide to calculating payroll deductions for employees. Check with your local state government website and follow IRS guidance to be sure you’re making accurate calculations.
1. Obtain the employee’s W-4 form
The W-4 form, signed when the employee was hired, includes most of the information you’ll need to be sure you’re making accurate deductions and withholding the right amount from the employee’s paycheck.
2. Calculate the employee’s gross pay
This is the amount of money earned before any deductions have been made. This should include any overtime, bonuses, tips, or other additional income.
3. Deduct pre-tax contributions
As described above, pre-tax contributions include things like medical insurance, charitable donations, and 401(k) plans. Employees generally don’t pay tax on income they set aside for these purposes.
4. Calculate FICA taxes
Withhold 7.65% of the adjusted gross pay to cover Social Security and Medicare taxes. There are specific rules that apply to high-earning employees, so make sure to check the IRS website for more information.
5. Calculate federal income tax
Use the IRS withholding calculator to determine which federal tax bracket the employee falls into and the amount of income tax that should be withheld from their paycheck. This will vary depending on the employee’s filing status and their annual income, and ranges from 10% to 37%.
6. Check your state’s tax rules
Each state has different rules around how state income tax is charged and collected, so refer to your state’s tax guidance information to determine how much of an employee’s adjusted gross pay needs to be withheld.
7. Subtract any post-tax deductions
This will include any deductions required by law, such as child support payments or wage garnishments. This might also include some post-tax voluntary deductions. Make sure to check with the employee to ensure that these amounts are accurate.
8. Calculate net pay
Subtract all deductions from the employee’s gross pay to calculate their net pay. This amount should appear in the employee’s bank account when they’re paid, also known as “take-home” pay.
The content of this article is based upon the personal opinion of the writer and not necessarily the views of WeWork or its employees. This content should not be considered professional advice, and the statements within the content should not be used without the advice of a third party professional with expertise in the relevant field. WeWork assumes no responsibility or liability for any errors or omissions in the content of this article. The information contained in this article is provided on an “as is” basis with no guarantees of completeness, accuracy, usefulness or timeliness and without any warranties of any kind whatsoever, express or implied.
Steve Hogarty is a writer and journalist based in London. He is the travel editor of City AM newspaper and the deputy editor of City AM Magazine, where his work focuses on technology, travel, and entertainment.