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What Are Payroll Deductions?

Written by:

Edited by:

Reviewed by:
Daniel Eisner and Mark Stewart

Published on September 21, 2022

Updated on November 17, 2022

What Are Payroll Deductions?

What Are Payroll Deductions?

Starting a business comes with many challenges, and if you’re hiring employees, payroll is sure to be one of them. The payroll process is quite complex due to countless regulations at the federal, state, and local levels. 

Payroll deductions are a key part of the process you’ll need to understand if you hope to be able handle it smoothly. Fortunately, this guide has you covered with all you need to know about payroll deductions. 

What Are Payroll Deductions?

A payroll deduction is any money withheld from an employee’s pay. There are two main categories of payroll deductions – mandatory and voluntary.

young accountant working on laptop and calculator

Mandatory Payroll Deductions

Mandatory payroll deductions are amounts that are required by law to be withheld by the employer. 

Income Tax

Income tax is paid by the employee at the federal, state, and local levels. At the federal level, the rate depends on the employee’s tax bracket. State and local taxes may or may not have fixed rates.

How much is withheld for federal income tax also depends on the employee’s W-4, which they should fill out at the time of hire. The W-4 specifies the employee’s filing status, dependents, and any additional withholding requests. 

In states that charge income tax, and most do, employees will fill out a state withholding form. 

To calculate federal income tax withholdings, you’ll need to refer to IRS Publication 15. For state income tax, you’ll need to refer to state-specific resources. The same is true for local taxes. 

FICA Tax

FICA taxes withheld from employee paychecks are to fund Social Security and Medicare. The employer also makes a tax contribution to those programs. 

Social Security tax is paid by the employee and the employer at a rate of 6.2 percent of the employee’s wages, while Medicare tax is also paid by both the employee and the employer, but at a rate of 1.45 percent.

For Social Security, there is a maximum wage limit. As of the 2022 tax year, if an employee makes more than $147,000, Social Security taxes do not have to be withheld. 

Medicare does not have a maximum wage limit, but any individual that earns more than $200,000 per year must pay an additional 0.9 percent.

Wage Garnishments

If a court or government agency orders garnishments of an employee’s wages for an unpaid debt, you must make the mandatory deductions from the employee’s pay and pay those amounts to the appropriate body. 

Voluntary Payroll Deductions

Voluntary payroll deductions are for any benefits the employee chooses to receive.

Health Insurance Premiums

If you’re providing healthcare benefits to your employees, you’ll need to deduct their premiums. Amounts  vary depending on which plan the employee chooses and how much you’re contributing to those premiums. Healthcare benefits may include medical, dental, and vision.

Life Insurance Premiums

If you’re offering life insurance benefits, you’ll deduct life insurance premiums. Again, amounts will vary based on the plan chosen. 

Retirement Plan Contributions

If you’re providing retirement plans for employees, such as Individual Retirement Accounts (IRAs) or 401Ks, you’ll need to deduct the amount of the employees’ contributions. There are maximum amounts that may be contributed pre-tax, meaning that federal income tax is not withheld from those amounts.

The maximum is $20,500 for 2022, or 100 percent of the employee’s income, whichever is less. 

Job-Related Expenses

Job-related expenses might include union dues, uniforms, use of a company car, or meals. Those expenses will be deducted from employee paychecks.

Using a Payroll Service

Processing payroll, calculating deductions, and dealing with taxes gets complicated, so you might want to consider using a payroll service. It’s likely to be less expensive than creating a new staff position for managing payroll. 

Payroll and payroll taxes come with countless laws and restrictions, and a payroll service can ensure your business remains in compliance at the federal, state, and local levels. You’ll just send over your digital timesheets and relevant information and the service provider will take care of the calculations, payments and taxes, freeing you up to focus on growing your business. 

We highly recommend hiring a payroll service — as a busy entrepreneur, you won’t regret it!