When an amount or any expense is deducted from an employee’ salary by the employer before the taxes are withheld, it is called before tax deduction. It reduces any payable amount to the government by a citizen. It also increases the income of the employees.
This indeed is beneficial for the employee as it reduces the taxes, and they owe less to the Federal Insurance Contributions Act, FICA, and get medical coverage and life insurance.
Types of before tax deductions
There are various before tax deductions or pre-tax deductions that reduce the taxable income of the employee. These are
- Retirement contributions
According to Forbes, “There are a number of retirement plans an employee may contribute to, for example 401(k), SEP and SIMPLE IRA. Typically, the employer determines the type of plan that is made available. It is the employee who decides the amount that is to be contributed. this is usually done through automatic payroll deduction.”
Difference Between Before Tax Deductions and Payroll Deductions
Before tax and additional payroll deductions, set aside money from an employee’s check for uses. Their gross pay is lowered as a result. Payroll deductions are all before tax deductions, however not all payroll deductions are before tax withholding.
What is meant by “payroll deductions” is the amount of money deducted from an employee’s paycheck for various purposes such as federal income tax (FIT), benefits contributions, and garnishments for unpaid child support. The paychecks for employees should show both required and optional payroll deductions.
Only contributions made of an employee’s paycheck prior to taxes being deducted are referred to as pre-tax deductions.
Benefits of before tax deductions
Before tax deductions have proven to be beneficial to both the employer and the employee. Before tax deductions allow employees perks such as medical coverage, pension, transportation, etc. and helps them save money.
Before tax deductions have mostly proven to be advantageous. The Social Security and Medicare tax may apply to some pre-tax deductions, so the Social Security and Medicare tax can be based on a higher income. This way, the employee may benefit, boosting the future credit balance and advantages from these schemes.
Limitations of before tax deductions
Even though before tax deductions are mostly beneficial, it’s still associated with some limitations.
- Contribution limits: many before tax deductions are subjected to contribution limits set up by IRS. Exceeding these limits may result in penalties.
- Limitations for highly compensated employees: Before tax deductions may have additional restrictions for employees with high salaries. “These restrictions aim to prevent disproportionate benefits from pre-tax deductions compared to lower-paid employees.”, as per Forbes.
- Eligibility requirements: some before tax deductions have eligibility requirements which are based on factors like employment status, income, etc.
When an amount or any expense is deducted from an employee’ salary by the employer before the taxes are withheld, it is called before tax deduction. It reduces any payable amount to the government by a citizen.
There are various types of before tax deductions, some of which are healthcare insurance, life insurance, retirement contributions, commuter benefits, parking privileges, etc.
Before tax deductions have mostly proven to be beneficial to both the employer and the employee as it allows the employee perks such as medical coverage, pension, transportation, etc. and helps them save money. There are also a few limitations to this as well. Limitations such as contribution limits, limitations for highly compensated employees, eligibility requirements, rules to specific plans, changes in employment, etc.
FAQs
- What are before tax deductions ?
Before tax deductions refers to a certain amount that is deducted from an employee’s paycheck before the taxes. These include retirement plans, health insurance, life insurance, etc.
- What are the types of before tax deductions ?
Before tax deductions are of many types, few of which are, healthcare insurance, life insurance, retirement contributions, commuter benefits, parking privileges, dental insurance, long term and short-term disability, childcare, etc.