What are payroll deductions and when do they happen?

Small Business Guides

3 min read

Businesses are sometimes required to take money out of an employee’s earnings. Learn more about payroll deductions such as benefits, taxes and garnishments.

What is a deduction?

A deduction is a payment you make out of an employee’s earnings, on their behalf. Some deductions are required by law. Others are voluntary. The four common types are:

  • tax (compulsory)

  • garnishments (compulsory)

  • retirement (voluntary)

  • health insurance (voluntary)

If you have a full or part-time employee, you will have to make deductions like these. The order in which you make them matters – and it can get complicated. A health insurance contribution, for example, may come out either before or after tax depending on its type. Let’s work through deductions in sequence.

Pre-tax deductions

Some deductions are taken out before tax. This allows you to provide benefits to your employees without increasing their tax bill. Pre-tax deductions can include:

  • Employer-sponsored healthcare insurance
    To deduct health, dental or vision insurance before tax, ensure your insurance plan is considered a pre-tax benefit. There are many pre-tax plans to choose from. Health Savings Account, Flexible Spending Accounts and Dependent care contributions are all made before tax as well.

  • Employee retirement contributions
    If you offer a retirement plan, employee contributions aren’t considered taxable for income tax at the time of contribution. The employee can choose to contribute up to the contribution limits set by the IRS.

  • Employer retirement contributions
    If you have set up a retirement plan for your employee, you can generally match their contributions tax free (but always check your plan for restrictions)

Tax deductions

All employees have to pay federal payroll taxes. Some may also have to pay state payroll taxes. Employers are expected to:

  • work out what each employee owes and take it directly from their earnings

  • pass that money onto the appropriate government agencies

  • submit reports that show the correct taxes were paid

This can be a big and complex step. You can find out more in our guide on payroll taxes.

Post-tax deductions

There may be more deductions to make after tax. These amounts are taken out only after the employee has paid tax on their income.

  • Employee-paid insurance
    If you offer health insurance that isn’t part of a pre-tax benefit plan, the payments your employee has authorized you to make on their behalf come out after tax.  

  • Roth employee retirement savings
    If employees have the option to contribute to a Roth IRA, Roth 401(k), or Roth 403(b) with your company, then take out those payments after tax.

  • Garnishments
    Some employees may be legally required to make certain payments every time they’re paid. These garnishments are taken out after tax.

What are garnishments?

Garnishments are legal documents that require businesses to collect a debt that’s owed by an employee. Employers are required to take this money out after tax and send it directly to the garnishor.

Common garnishments include child support and tax levies (such as penalties on late tax payments), old tax bills, or government loans. Some private lenders can also garnish an employee’s earnings.

Staying on top of deductions

Deductions are what make payroll complicated. Each employee can have several deductions and the amounts involved may change from pay run to pay run depending on:

  • how much they earn in that period

  • their personal circumstances

  • their choices concerning voluntary contributions

Check all these things before each pay run. If you’re working out the deductions manually, then set a decent amount of time aside for the job. If you have several employees, it might make more sense to use software which can do the calculations for you.