What are pre-tax deductions?

Pre-tax deductions are any amounts taken from an employee's gross pay before taxes are deducted from their pay. These  deductions reduce the employee's taxable income, which means they'll owe less income tax. They   may also owe less  Federal Insurance Contributions Act (FICA) tax , which covers Social Security and Medicare.

 Pre-tax deductions can also reduce taxes paid by the employer such as  Federal Unemployment Tax Act (FUTA)  , FICA, and  state unemployment insurance (SUI) .

Pre-Tax Deductions vs. Salary Deductions

Both pre-tax deductions and other  payroll deductions  allocate a portion of an employee's pay to specific purposes. This reduces their  net pay  (take-home pay). All pre-tax deductions are payroll deductions, but not all payroll deductions are withheld on a pre-tax basis.

The term ""payroll deductions"" refers to amounts deducted from an employee's pay to account  for deductions such as federal income tax (FIT)  and other charges,  benefit  contributions, and outstanding child support payments  . Mandatory and voluntary payroll deductions  must be shown  on an employee's pay stub  .

Pre-tax deductions simply refer to contributions that   come from an employee's salary before taxes are deducted.

Pre-Tax Deductions List

The federal government  may change the rules regarding pre-tax deductions on an annual basis  . Regulations and limits are also subject to change. Be sure to check the updated information about paycheck deductions before modifying payroll. Here is a list of items that generally qualify as pre-tax deductions (as of 2023):

• Health insurance
• Health Savings Accounts (HSA)
• Supplemental Insurance Coverage
• short term disability
• Long Term Disability
• Dental Insurance
• Dependent Care Benefits
• Medical Expenses and  Flexible Spending Accounts (FSA)
• Insurance
• Passenger Benefits
• Retirement contributions
• Tax-Deferred Investing
• Vision benefits
• parking permit

Benefits of Pre-Tax Deductions

Pre-tax deductions are beneficial to most employees and employers. Using a pre-tax deduction plan allows employees to receive coverage and perks such as medical care and life insurance before their  gross income  is taxed. This reduces the employee's tax burden and usually saves them money over time. For example, an employee will often pay less for health coverage than they would if they purchased a private plan with after-tax dollars.

The pre-tax deduction is beneficial, but most plans have a limit on the amount of contributions that can be made in a year. This means that employees don't get infinite savings from their pre-tax contribution program.

Some pre-tax deductions  may also be subject to Social Security and Medicare taxes.  Therefore, the Social Security and Medicare taxes paid by the employee may be based on more gross income than shown for calculated income taxes. This may help the employee increase the credits and benefits they receive from these programs in the future.

Do pre-tax deductions reduce taxable income?

Yes, pre-tax deductions almost always reduce taxable income for an employee. This is because the money is taken from the employee's gross pay, leaving a lower amount subject to tax deductions. Pre-tax deductions can also reduce taxes for an employer who pays FUTA, FICA, and SUI.

Pre-tax deductions  change each year  . They are adjusted by the federal government according to inflation and the cost of living. This can affect how much taxable income is reduced from one year to the next.

In contrast,  after-tax deductions  do not reduce an employee's taxable income—the employee's pay is already taxed before the money is taken from the paycheck. After-tax deductions can include many items, such as union dues, charitable donations, certain retirement contributions and benefits that exceed the pre-tax deduction limits.

Examples of Pre-Tax Deductions

Many types of deductions and contributions can be considered pre-tax. Here's an example of calculating a pre-tax deduction:

• An employee's gross pay per pay period is $1,000.
• They also get an HSA deduction of $50 per pay period.
•  This brings the employee's taxable income to  $950 ($1,000 - $50).

At this point, you can withhold taxes from the employee's pay. Taxes should not be withheld before deducting the employee's HSA (and other qualified contributions, if applicable).

Other examples of pre-tax deductions include:

Retirement Fund

Retirement plans like the traditional  401(k)  can be considered a pre-tax deduction. Both employees and employers can make contributions before income is taxed.

Health insurance

Health benefit plans such as an HSA or  FSA  are considered pre-tax deductions. Company-sponsored health insurance may also allow a pre-tax deduction for employees who voluntarily pay for health coverage.

Passenger Benefits

Commuter benefits are a type of qualified  fringe benefit  that goes into an employer-funded account, which is considered a pre-tax deduction. For example, an employer might put $100 each month into a commuter account for a bus pass or train ticket.