What are Pre Tax Deductions | Demystify Your Payslip
You know your pre-tax deductions. Your payroll deductions, healthcare, and other employee-deducted fees found in your W-2 form. However, do you realize those pre-tax deductions are calculated differently from post-tax deductions?
You might see a smaller amount upfront, but pre-tax deductions can save you money. But if you’re still confused about the different rules for deductions, then continue reading for a quick bite about your pre-tax deductions. Best of all, you would learn how to get more benefits and maximize your deductions.
Pre-tax deductions are amounts deducted from your payroll before it becomes taxable.
Employers use this to cover employee benefits. Pre-tax payroll deduction is particularly beneficial for you because it reduces the withheld tax. It also reduces an employee’s liabilities for federal income tax and FICA tax.
There are some tax deductions that you and your employer can choose to treat one way or the other. However, we categorize certain tax deductions are as post- or pre-tax.
1.Taxing Your Income
Say you’re earning $1,000 bi-weekly and $50 is deducted every paycheck to pay for employee benefits. When the amount gets deducted before taxes are withheld, only $950 becomes taxable income.
On the other hand, taxing the full $1,000 and then deducting the $50 reduces the take-home pay of the employee. This is called post-tax deductions, or deductions made after the IRS applies withholding taxes.
2. Check The Withholding Tax Limits
However, pre-tax deductions aren’t always the best method to use.
There are rules and thresholds that might make after-tax deductions more favorable for you.
Regularly check the tax withholding rules and the different limits set by the IRS. Then, devise your game plan to reduce your tax liabilities and maximize the employee benefits given by your employer.
What Are The Different Pre-Tax Deductions?
Your employer applies these pre-tax deductions before you receive your payslip. You earn a lower income, but this also translates to lower tax withholdings.
Here Are The Most Common Employee Benefits
1. Health Benefits
Section 125 cafeteria plan covers health benefits that are pre-tax deductions.
This includes health insurance policies and accident insurance. The amounts deducted are also used to pay for Health Savings Accounts. However, some health benefits have special tax withholding rules. They are also limited to a specified maximum amount for contributions.
As mentioned earlier, you can apply some deductions before or after withholding taxes.
First, Dental, Vision and Medical benefits are some deductions eligible for either post- or pre-tax deductions. Also, you might want to think about the cost of getting your health insurance policy separate from your employer.
No claims over itemized health care expenses
The downside to pre-taxing health benefits for your employer-provided health insurance is that you have no claim over itemized medical expense tax deductions. You can only claim these deductions for personal health policies.
2. Transportation Allowance and Programs
Some employers offer additional benefits to their employees through transportation coverage such as public transportation and parking fees.
Other transportation programs might have limits, and any amounts above may not be exempted from taxes anymore.
Just like some health benefits, parking fees are also eligible for either post- or pre-tax deductions. There are also limits as to the number of parking fees the employer can include for pre-tax deductions.
3. Retirement Accounts
Traditional IRAs and some 401(k) accounts are eligible for pre-tax deductions.
Beef up your retirement funds. But take note of the threshold as to how much you can contribute annually to your account.
Retirement contributions are typically exempt from all employment taxes. However, some plans are only exempt from income tax but not from Social Security and Medicare taxes. It’s best to check your policy to see the specific tax regulations.
Post-tax silver lining
Although pre-tax deductions seem more appealing overall, this is where you can see the silver lining of post-tax deductions.
When you put pre-tax dollars into your retirement accounts, you are not avoiding taxes on those funds. Once you retire, the IRS gets to take a bit from your funds.
However, when you contribute funds post-taxes, you get the entire cake when you retire.
4. Life Insurance
The government exempts life insurance provided by the employer.
However, a limit of $50,000 per coverage is imposed to be eligible for FICA tax exemptions.
To qualify for tax exemptions, get coverage under a group plan. Contributions to your Flexible Savings Account are also eligible for pre-tax deductions, given that you don’t go beyond the cap set by the IRS.
What Are The Post-Tax Deductions?
After-tax deductions are self-explanatory. They are amounts deducted after taxes are withheld from the employee’s paycheck. It does not affect taxable income.
What is affected by post-tax deductions?
- Voluntary life insurance (Employee, Spouse, and Child)
- Roth 401(k) for small business retirement plans
- Long-term disability and short-term disability
- Charitable donations
- Personal Accident (AD&D)
What Are Garnishments?
When you owe a debt that is past due, your employer may be ordered to garnish your wages.
This method is used by a government agency or by a court of collecting unpaid debt through employers. The extra amounts withheld from your paycheck go to debt payments.
What Will Be Affected?
The government will garnish all income including salaries, bonuses, and commissions.
Only disposable earnings can be subject to garnishments. This means payments for debts can be deducted only on amounts after federal, state, and local taxes.
Other Payment Liabilities
Aside from taxes, we might have other payment liabilities that we need to pay.
If we are far behind payments, the government might go after the amounts we owe through our employers. These are the different types of debt that can be lead to garnishments:
- Unpaid taxes
- Outstanding medical bills
- Delinquent card, car, or other loans
- Student loans
- Overdue child support
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