What Are the Common Types of Payroll Deductions?

By Krystal Etienne · January 18, 2023 · 11 minute read

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What Are the Common Types of Payroll Deductions?

Who doesn’t love receiving a paycheck and knowing you can use it to pay bills or maybe even indulge in a little splurge or two? But when you see just how much you are taking home as net pay vs. gross pay, it can be a little deflating.

Looking more closely at your paystub or direct deposit receipt, you’ll see several line items that are called “deductions.”

Deductions are all of the things that were taken out of your gross pay, leaving you with your net pay, or take-home pay.

While there are some deductions that are required by law and are out of your control, others are part of your employee benefits package, which means that you may be able to adjust them according to what works for you and your budget.

Read on for a paycheck breakdown that can help you understand exactly what is coming out of your paycheck and why, including:

•   What are common payroll deductions?

•   How do payroll deductions work?

•   What are tips to manage payroll deductions?

What is Net Pay?

Whether you’re paid hourly or by salary, your rate of pay is the compensation that you and your employer agreed upon when you accepted the job.

This number appears in official contracts and is referred to as your gross pay. However, it does not represent the actual amount that you will be paid.

Net pay, also referred to as take-home pay, is the compensation that is paid out via check or direct deposit to an employee. It is your gross pay with all the deductions taken out, which can make you think, “Wait, where’d my money go?” when it hits your checking account.

What Are Payroll Deductions?

So, to answer that question: Here’s where your money goes:

•   Mandatory deductions: By law, an employer must subtract various mandatory federal and state tax withholdings.

•   Elective deductions: Employers will also subtract costs for employer-sponsored offerings that the employee takes part in, such as healthcare, life insurance, and retirement.

Whether required or optional, these are pulled out of your gross pay and applied where needed. While you may feel disappointed to see these funds siphoned off, they have an upside. They are saving you from owing major taxes come April 15, and they are potentially helping provide important elements of financial fitness, like saving for your future. This knowledge can be reassuring, especially if you are filing taxes for the first time, and are feeling a bit shocked about the difference between your gross and net pay on an annual basis.

How Do Payroll Deductions Work?

As mentioned above, payroll deductions may be required, such as federal or any state taxes, or they may be optional (say, a 401(k) plan or health insurance). The mandatory and elective deductions are subtracted from your paycheck’s gross pay amount.

What remains after these payroll deductions is your net pay. This is the amount that is paid to you. You can typically see a breakdown of exactly what has been subtracted from your compensation by looking at your paystub. If you are paid via direct deposit, you will likely find this information online at your employer’s portal. If you receive a paper paycheck, the paystub is often attached.

Types of Payroll Deductions

As you look at your paystub and see all the deductions that are being taken out of your gross pay, you may want a bit of help understanding what’s what. Below are explanations of some of the most common paycheck deductions:

Federal Taxes

Federal taxes include all the taxes you are required by law to pay to the federal government. These taxes (which are often referred to as being withheld vs. paid) help fund the federal government, allowing them to invest in things such as infrastructure, education, and national defense, and provide services to the American people.

What is tax withholding and how much must you allocate towards it? When you were first hired, you likely filled out an Employee’s Withholding Certificate or W-4 form form and claimed the number of tax exemptions you have. This amount tells the federal government how much money to take out of each paycheck to cover your taxes. The more allowances you take, the less federal income tax the government will take out of your paycheck.

One way to ensure that you have the right amount of tax withheld for each pay period is to use the IRS Tax Withholding Estimator or speak with someone in your company’s HR department. You can tell them if you’re single or married, how many dependents you have, and if you have any other sources of income, and they should be able to help you fill out your form accurately.

It’s also a good practice to revisit your W-4 selections annually as significant life events may change your withholding and also because the W-4 form is periodically updated.

During tax season of each year, individuals who have overpaid in federal taxes receive a refund from the government. Those who’ve underpaid, however, are required to pay additional funds and possibly a penalty.

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State and Local Income Taxes

There are other types of taxes that will possibly be withheld from your gross pay. Many states require a state tax to help fund government projects and services. The amount can range anywhere from 3% (Pennsylvania) to 13% (California). To learn more about your state’s taxation policy, you can look at this map for details.

Just as with federal taxes, your state income tax will get deducted from your paycheck to cover taxes you may owe at the end of the year.

Social Security and Medicare

Another common paycheck deduction you’ll see: Social Security and Medicare taxes that are part of the Federal Insurance Contributions Act (FICA) tax, a group of payroll taxes collected from both the employer and the employee. As the name implies, these taxes fund our nation’s Social Security and Medicare programs, helping with income and insurance needs once you reach retirement age.

The tax rate for social security is currently 6.2%, and Medicare receives an additional 1.45% (employers match these tax rates, bringing the total of FICA tax contributions to 15.3%).

Wage Garnishments

Another possible payroll deduction to know about: wage garnishments. These are legal procedures designed to repay delinquent, outstanding debts, such as unpaid child support, overdue credit card payments, or even unpaid taxes.

Most wage garnishments are initiated by court order. However, the IRS and other tax collection agencies also levy for unpaid taxes in the form of wage garnishment.

Garnishments are made on earnings leftover after all legally required deductions are made. The actual amount of any garnishment will depend on the amount of debt owed and income earned.

Employee Benefits

Depending on where you work, you may be able to opt into a variety of benefits. Typically, these costs are automatically deducted from your paycheck.

If you sign up for your employer-provided health insurance, at least some of the cost is likely to be a type of paycheck deduction.

Under the Affordable Care Act, employers with 50 employees or more must offer affordable health insurance. As part of an employee’s compensation package, many companies will pay half, or another percentage, of the insurance premiums. The employee’s portion of those premiums is represented on a pay stub as a deduction.

Other benefits, like flexible spending plans, commuter plans, and life insurance, may also be deducted from your pay, depending on whether or not you opt into them and if your employer picks up the bill fully or partially.

Health insurance and other benefits typically come out before your taxes, and you may be able to reduce your taxable income by signing up for them.

Recommended: Guide to Employee Benefits

Retirement Contributions

Employee savings plans such as 401(k)s are a common benefit offered in the workforce.

If you opt into this benefit, your employer will deduct funds from your wage earnings and deposit them into a retirement account. (How much of your paycheck should you save? Experts often recommend 20% should go towards saving for retirement and other short- and long-term goals.)

Employees are typically able to choose the amount they would like deducted from their earnings for retirement savings. In some cases, employers may contribute an additional percentage of your salary into your retirement account.

Contributions to your 401(k) not only help you save for the future, but lower your taxable income, since they come out of your paycheck before taxes get assessed.

You’ll want to keep in mind, however, that there are yearly retirement plan contribution limits set by the federal government through the IRS.

Other Common Payroll Deductions

Depending on your workplace and career, other payroll deductions are possible. Among the ones you may find are:

•   Charitable giving plans

•   Payment for job-required items, such as tools or uniforms

•   Union dues

•   Professional certification or tuition fee deductions

Examples of Payroll Deductions

You’ve learned details about many types of payroll deductions above. In list form, examples of payroll deductions include:

•   Federal income tax

•   State and local income taxes

•   Social Security and Medicare taxes

•   Wage garnishments

•   Employee benefits

•   Retirement contributions

Steps to Calculate Payroll Deductions

Calculating payroll deductions is typically something done by employers, not employees. Here’s a quick overview of how the process typically works:

1.    Obtain a W-4 from employees indicating their withholding.

2.    Determine employees’ gross earnings, whether salary pay or hourly.

3.    Calculate any overtime for those employees who are not exempt and worked over 40 hours a week.

4.    Take any pre-tax deductions.

5.    Calculate and deduct federal income tax based on pay, withholding status, what tax bracket an employee is in, and other factors.

6.    Determine and deduct Social Security and Medicare payments.

7.    Calculate and deduct any state and local taxes.

8.    Take any other deductions, and move funds to the appropriate entity.

Tips to Manage Payroll Deductions

If you are an employee seeking to tweak your deductions, you will have a few options. You might update your W-4 to reflect more or fewer exemptions, depending on whether you want to reduce or increase the taxes withheld.

In addition, if you could use some breathing room in your budget during a financial crunch, you might decrease retirement contributions a notch to free up a little more money for bills.

If you are in a position to be managing payroll deductions, consider these tips for making the process run smoothly:

•   Develop organizational systems to manage forms, deadlines, and other aspects of the process. There are many digital and online tools you can use for this.

•   Keep up to date with federal, state, and local tax laws to make sure you are deducting the proper amounts; know the guidelines about, say, equal pay provisions; and more.

•   Automate the entire process with payroll software. This can save time and boost accuracy versus doing things by hand. Or consider outsourcing the responsibilities to an external agency.

•   Regularly update training for payroll and HR teams, if you employ them.

•   Don’t touch payroll taxes that are only paid quarterly. It may be tempting to dip into those funds before they are due and use them for other business expenses, but this is a very risky path to pursue. If you wind up being short when the taxes must be paid, you could face penalties.

The Takeaway

While you may be surprised to see all the deductions coming out of your paycheck, once you know what number to expect to see landing in your bank account each pay period, you’ll be able to plan your spending and budget accordingly.

It’s a good idea to check your pay stubs periodically to ensure that the deductions being taken out are accurate and align with your financial goals.

If you haven’t maxed out your 401(k) contributions, for example, you may decide to increase them as your income grows and you become more financially stable.

To make sure the appropriate amount of taxes are being withheld from each paycheck, you may also want to revisit your W-4 annually and make any adjustments as your circumstances change.

Another good way to keep close tabs on your earnings and spending is to open an online bank account with SoFi. With our Checking and Savings account, you’ll enjoy an easy-to-read dashboard, the convenience of spending and saving in one place, and automatic saving features that help you organize your cash, track spending, and stash your change with Vaults and Roundups. Qualifying accounts with direct deposit can get paycheck access up to two days early, which can give you a headstart on managing your money. And with SoFi, you’ll earn a competitive APY and pay no account fees.

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What are some common incorrect payroll deductions?

Examples of incorrect employee payroll deductions are expenses that have to do with running the business, workers’ compensation premiums, and some personal protective gear costs. In addition, payroll deductions should not bring an employee’s income below minimum wage.

How do I report payroll deductions?

If you are an employee, your payroll deductions will be reflected in the end-of-year W-2 form that you receive. If you are an employer, you are likely filing IRS Form 941, Employer’s Quarterly Federal Tax Return, or Form 944, Employer’s Annual Federal Tax Return, which shows the wages you’ve paid and various taxes withheld.

What are the pros and cons of payroll deductions?

Payroll deductions are a fact of life. On the plus side, they whisk away taxes regularly so you don’t face a huge tax bill come April 15, and the money paid in taxes can help quality of life in America. Also, deductions like health insurance and retirement savings go towards achieving financial security. The main con, of course, is that you take home less pay than your gross earnings and may need to budget wisely to balance your spending and saving.

What are the categories of payroll deductions?

The main categories of payroll deductions are federal, state, and local taxes; Social Security and Medicare; employee benefits; and retirement contributions.

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