- Payroll deductions are amounts withheld from employees’ paychecks to cover expenses such as taxes and benefits.
- Mandatory withholdings include federal, state, and local taxes as well as FICA (Medicare and Social Security).
- Voluntary deductions include health insurance premiums and 401(k) contributions.
- This article is for business owners who are interested in learning about payroll deductions.
As a business owner, you are responsible for ensuring that payroll withholdings are performed on time and correctly, even if you use a payroll service. These deductions are calculated each pay period and include mandatory withholdings – such as federal, state and local taxes, as well as FICA (Medicare and Social Security) – and voluntary deductions, like health insurance premiums and 401(k) contributions.
What are payroll deductions?
Payroll deductions are amounts withheld from employees’ paychecks each pay period to cover expenses such as federal, state and local income taxes, as well as employee benefits, like health insurance. These amounts are deducted from each employee’s gross pay to calculate their net pay each pay period.
Here are some common examples of payroll deductions:
- Income taxes. Federal, state and local taxes are deducted from the paychecks of W-2 employees. Withholdings are based on employee income, applicable tax rates, employee dependents and other adjustments indicated on IRS Form W-4.
- FICA. Deductions are also made for Federal Insurance Contributions Act (FICA) tax, including deductions for Medicare and Social Security premiums.
- Health insurance. Any employee portion of health insurance premiums are deducted each pay period.
- Retirement plan contributions. Employee contributions to employer-sponsored retirement plans, like a 401(k), are also deducted.
Did you know?: These deductions are a standard part of payroll accounting. To learn more about how to process your employees’ pay, visit our guide to payroll accounting.
How do payroll deductions work?
Payroll deductions are taken from employee paychecks every pay period. These amounts are calculated for each employee based on their gross earnings for that pay period, potentially with taxes based on an estimate of the employee’s annualized income. Amounts withheld from an employee’s paycheck are then paid on their behalf to taxing authorities, insurers or other recipients.
Every time an employer runs payroll for their employees who worked during the pay period, each worker’s deductions are calculated based on their earnings. Deductions are then made for income taxes, FICA, garnishments and any other mandatory items, as well as for benefits such as health insurance and retirement plan contributions.
Because deductions are based on an employee’s earnings for a particular pay period, it’s important to understand payroll frequency. To learn more, check out our guide to deciding how often to run payroll.
What are the main types of payroll deductions?
Payroll deductions fall into two general categories: mandatory and voluntary. Mandatory deductions are for payroll taxes, such as income tax and FICA, while voluntary deductions are for benefits such as health insurance and retirement plans.
Mandatory payroll deductions
Here are some typical mandatory payroll deductions:
- Income tax. Deductions for federal, state and local taxes are mandatory, if applicable.
- FICA. Medicare and Social Security premiums are required, and the amounts are based on the employee’s income.
- Wage garnishments. Any court-ordered wage garnishments for taxes, child or spousal support, or other ordered amounts are mandatory.
In certain circumstances, there may be other distributions that employers are required to deduct on the employee’s behalf.
Voluntary payroll deductions
Here are some common voluntary payroll deductions:
- Health insurance. If an employee gets health benefits from their employer, any employee portion of the monthly premiums are deducted from the employee’s paycheck. [Looking for more information on health insurance? Check out our small business guide to health insurance.]
- Other insurance premiums. Some employers offer other types of insurance, such as life insurance, and premiums for these coverages are also deducted.
- Retirement plan contributions. Employee contributions to employer-sponsored retirement plans, such as a 401(k) or a SIMPLE IRA, are also deducted if the employee elects to participate.
The amounts of both mandatory and voluntary deductions can vary over time, though mandatory deductions don’t change much as a result of employees’ decisions, except for altering their number of withholding allowances. Amounts of voluntary deductions, however, can be adjusted.
Did you know?: Some companies are required to offer health insurance to employees. If you’re wondering whether this applies to your business, check the latest business health insurance requirements.
Items that shouldn’t be deducted
Certain things should not be deducted from an employee’s paycheck. For example, employers are responsible for unemployment insurance (FUTA) and workers’ compensation premiums.
How to calculate payroll deductions
Follow these steps to calculate payroll deductions:
- Calculate gross pay. Add up the employee’s total gross earnings for the pay period.
- Determine the tax rate. Multiply the employee’s annualized income (earnings for the pay period times the number of pay periods in a year) by applicable federal, state and local tax rates.
- Calculate FICA withholding. Include deductions for Social Security and Medicare, which are based on established rates and are subject to income limits.
- Include garnishments. If an employee is subject to court-ordered wage garnishments, calculate those deductions.
- Add voluntary deductions. Divide annual premiums for any voluntary deductions by the number of pay periods.
- Determine the total net pay. Add up all of the mandatory and voluntary deductions, and deduct the total from the gross earnings to determine the employee’s net pay for the pay period.
- Pay the deduction amounts. Once you withhold the deductions from an employee’s paycheck, pay the withheld amounts on the employee’s behalf.
Although you can follow these steps to calculate payroll deductions manually, the process can be tedious and time-consuming, especially for companies with many employees. That’s why we recommend choosing a payroll service to do it for you. We’ve done extensive research to find the best companies and software for the job, and you can see our picks for the best payroll services.