As a small business owner, you’re responsible for making sure your employees get paid. But in addition to paying your employees, you’re also responsible for withholding some of that pay in the form of payroll deductions.
If you want to both make sure your paychecks are accurate each week and that you’re staying on top of any necessary tax withholdings or premium payments for each employee, understanding payroll deductions is a must.
But what, exactly, are payroll deductions? Why are they so important? And as a small business owner, what payroll deductions do you need to manage for your employees?
What are payroll deductions?
Payroll deductions are…well, exactly what they sound like. They’re deductions that are withheld from an employee’s paycheck each pay period.
Payroll deductions are the main reason there’s a discrepancy between an employee’s salary or hourly wage and the actual dollar amount they take home each pay period; payroll deductions are subtracted from an employee’s gross pay – and once those deductions are complete, they’re left with their take home pay (more commonly referred to as net pay).
There are two different types of payroll deductions – mandatory and voluntary. Let’s take a deeper look at both categories:
Mandatory payroll deductions
Mandatory payroll deductions are the deductions you’re required to withhold from your employee’s gross pay before issuing paychecks – and when we say required, we mean required by law.
The payroll deductions that fall under the “mandatory” umbrella? Payroll taxes. As an employer, you’re required to withhold payroll taxes from your employees and submit them to the appropriate tax agencies; failure to do so can lead to serious penalties for your business (not to mention a lot of time, hassle, and headaches).
There are a few different types of tax deductions that are mandatory to withhold from your employee’s pay, including:
- Federal taxes. All employees in the United States need to pay federal taxes. The income tax withholding for each employee is based on both their gross pay and IRS form W-4.
- State taxes. Every state has a different tax structure – but what’s uniform throughout all 50 states is that employers need to withhold taxes for their employees. In previous years, employees elected their withholdings using form W-4 – but in 2020, California changed their withholding schedule; in 2020 and moving forward, all new employees and existing employees wishing to change their withholding allowance must submit form DE 4.
- Local taxes. Depending on where your business is located, you may also be required to withhold local taxes to support your city and/or county.
- Social security tax and Medicare tax. Under the Federal Insurance Contributions Act (more commonly known as FICA), employers are also required to withhold taxes for Social Security (6.2 percent) and Medicare (1.45 percent) from the employee’s wages. (In addition to withholding FICA taxes from your employee’s pay, it’s also mandatory to pay FICA taxes as an employer.)
- Court ordered deductions. In certain circumstances, a court may order an employer to withhold an employee’s wages (for example, wage garnishments or to uphold court-ordered child support payments).
Voluntary payroll deductions
In addition to mandatory payroll deductions, there are a wide variety of additional withholdings that aren’t mandatory, but you may still need to deduct from your employees’ paychecks. These withholdings are called voluntary payroll deductions.
Voluntary payroll deductions typically cover benefits for your employees. The big caveat with these voluntary deductions? Employees need to opt in – and, as an employer, you need to have their written consent before you start withholding voluntary payroll deductions from their paycheck.
There are a variety of voluntary payroll deductions you may need to withhold from your employees’ wages, including:
- Retirement plans. If you offer ways for your employees to contribute to their retirement savings- for example, a 401(k) or IRA – you would deduct their elected contributions from their gross pay.
- Health insurance premiums. If you offer health insurance for your employees – including dental and vision – those premiums would be deducted from their paychecks.
- Flexible spending account or health savings account contributions. If you offer flex spending accounts or HSAs, employees can elect to contribute pre-tax dollars to those accounts – and you’ll need to deduct those contributions from their paychecks.
- Life insurance or disability premiums. Same goes for life insurance or short-term disability insurance plan premiums.
- Charitable giving. If your company sponsors a charitable giving plan, employees may elect to have contributions deducted from their pay.
- Union dues. If your employees belong to a union, you may need to deduct union dues from their gross pay.
Make sure you understand payroll deductions to avoid penalties
Clearly, there are a variety of payroll deductions you’ll need to withhold from your employees’ gross pay. But as an employer, it’s important to ensure you understand all mandatory payroll deductions you’ll need to withhold for your employees, any voluntary payroll deductions your employees elect to have withheld from their pay, and how much need to be withheld each paycheck. Otherwise, you could find yourself facing steep penalties and issues with your employees, benefit providers, and federal, state, and local governments.