Owning a business is both a challenging and rewarding experience. Achieving your business goals and increasing profit requires building a team of qualified employees. But, navigating payroll presents its own set of challenges.

Whether you are just starting your business or trying to hire for an existing business, figuring out payroll deductions is important. You need to ensure that the right wages are being deducted for each employee. Let’s jump into the details of payroll deductions.

What are Payroll Deductions?

Payroll deductions are wages that are withheld from employee payments to ensure taxes, garnishments, and benefits are properly processed. As an employer, you must ensure that you withhold wages for both hourly and salaried employees. It is not necessary, however, to withhold wages from independent contractors. 

Although it may seem like a headache to calculate and keep track of these deductions, there are actually some benefits to the practice. For example, there are some deductions that are completely optional such as health insurance.

Keeping track of your finances and, specifically, payroll can help you determine which additional deductions you want to make to attract better talent to your company.

What are typical payroll deductions?

Many payroll deductions must be withheld from employee wages. Typical deductions include things like income taxes, social security tax, and 401(k) contributions. Wage garnishments — for example, courts may order garnishments of individuals’ wages for child support, unpaid taxes, alimony, or defaulted loans — are another example of payroll deductions. 

Additionally, deductions can include various types of benefits that you choose to offer to employees. 

What are the two types of Payroll Deductions?

There are two types of payroll deductions: mandatory and voluntary. Mandatory payroll deductions are required by law. These are portions of wages that are withheld from hourly and salaried employee paychecks to meet tax and other required obligations. Voluntary deductions, on the other hand, are those that you choose to offer to employees such as insurance or a retirement plan. 

Mandatory Payroll Deductions

Mandatory payroll deductions include federal, state, or local tax withholdings. For example, federal tax withholdings include contributions to Social Security and Medicare accounts. For employees, 6.2% of taxable wages, up to $142,800 as of 2021, are paid to Social Security accounts. Medicare contributions amount to 1.45% of taxable wages with no limit. 

There are also other mandatory deductions like garnishments and child support. A garnishment is a court-ordered deduction from wages to satisfy the debt owed by an employee to a creditor.

Similarly, child support is court-ordered, which means that you are lawfully obligated to deduct an employee’s wages to satisfy the legal order. Although it may seem complicated, it is a necessary part of working with a diverse set of people with various backgrounds and skill levels.

Voluntary Payroll Deductions

Voluntary payroll deductions include health, life, and disability insurance or things like union dues, 401(k) plans, or flexible spending accounts. For example, flexible spending accounts or FSAs fall under pre-tax payroll deductions. FSA contributions are paid with pre-tax dollars which reduces an individual’s overall tax liability. They are exempt from federal payroll taxes or FICA (Federal Insurance Contributions Act).

Voluntary deductions require a written authorization from the employee before the deduction. Name, date, the reason for the deduction (e.g., FSAs), a dollar amount, and signature are required from the employee. 

How do I calculate Payroll Deductions?

Many possible deductions are either mandatory or voluntary. But how do you calculate them? It may feel overwhelming, but don’t be discouraged. Luckily, the internet is full of helpful resources including payroll deduction calculators, many of which are free.

For example, paycheckmanager.com has a free payroll deduction calculator. They require the state of employment, the employee’s W-4 information, their general paycheck information, and any non-tax and pre-tax deductions. Based on that information, and any after-tax adjustments (e.g., garnishments for child support), the calculator will provide a net pay value.

Similarly, onpay.com has a free payroll deduction calculator dedicated for employers. They provide some helpful information about deductions specific to the type of employees you have (hourly or salaried), FICA taxes, and unemployment taxes. They even have calculators for 401(k) withholdings, flat bonus tax withholdings, PPP loan forgiveness, and other possible deductions.

There are many options available to you as a business owner, online and for free. These helpful tools will ensure that you withhold that proper amount from employee payments and fulfill your deduction responsibilities. 

Which Payroll Deductions are required by law?

As mentioned above, mandatory payroll taxes are those that are required by law. You, as an employer, are required to and responsible for withholding wages from hourly and salaried employees’ paychecks to contribute to mandatory deductions. Payroll deductions that are required by law are:

  • Federal income tax withholdings
  • Social Security and Medicare taxes
  • State income tax withholdings
  • Local tax withholdings such as city or county taxes, state disability, or unemployment insurance
  • Garnishments
  • Child support

Which Payroll Deductions are exempt from FICA?

In addition to mandatory deductions, there are many voluntary deductions that you can choose to offer to employees. But remember, the employee must provide consent for these deductions.

Some voluntary deductions are exempt from FICA.  For example, some medical and dental insurance plans and FSAs are exempt from FICA. However, if you find that you are unsure of whether a particular voluntary deduction is exempt from FICA, make sure to check with an expert.

As a business owner, you wear many hats. You manage, you keep track of finances, you may even do the cleaning. It’s your hard work, vigilance, and organization that made this business, but your employees will keep it running. And to keep it running properly, ensuring that your employees’ wages are paid and that mandatory and voluntary deductions are processed is crucial for your success.

With the many resources available for you to accurately and quickly calculate payroll deductions, you can ensure that you meet your obligations, keep your business’s finances in order, and prepare your small business for tax season. Now that you know the basics of payroll deductions, the different types of deductions, and how to calculate those deductions, you are ready to enhance your business practices. 

Free insights to help you take control of business finances.
Discover the best tips, tricks, and tools for better money management.