Understanding your Payroll Deductions
What are payroll deductions?
Payroll deductions are taxes, benefit payments or wage garnishments that an employer withholds from employee earnings. They may also be called paycheck deductions. You must withhold paycheck deductions for all employees to whom you plan to issue a W-2 form, but not for any independent contractors or freelancers you work with.
What types of payroll deductions
With the start of tax season quickly approaching now is the perfect time to take a good look at your pay stub. It’s more than likely been awhile since you’ve taken a good look, especially if you have direct deposit. A regular review of your pay stub can ensure accuracy, but whether it’s your first or 100th pay stub, you may not understand what all the abbreviations and deductions mean.
Here’s a breakdown of the most common payroll deductions and the basic building blocks of a paycheck.
The Basics:
A pay stub generally includes:
- Your taxable earnings.
- Your gross pay – the total amount of money you earned in that pay period.
- You net pay – the amount of money you take home.
- Withholdings – these largely account for the difference between your taxable earnings and net pay.
Federal Income Taxes:
Federal taxes are calculated as a percentage of your income. When you start a new job, you fill out a W-4 form, or an Employee’s Withholding Allowance Certificate, to indicate the percentage of your income that you would like to be withheld. If the amount is too high, you will receive a tax refund after you file your yearly taxes. If you don’t have enough withheld, you will be responsible for the paying the balance. On your W-4 form, you are given the option to make allowances for yourself, your spouse and your dependents. For every allowance that you take, less money is withheld for federal taxes and more money is added to your paycheck. The fewer allowances that you have, the more money that will be withheld for your federal taxes.
State Income Taxes:
State taxes work like federal taxes, but are paid to the government of the state that you live in. Several states, including Texas, Nevada and Florida, do not collect state income tax.
Social Security and Medicare:
You are required by the federal government to contribute to Social Security and Medicare. Social Security is a system of supplemental retirement programs established in 1935. Every worker contributes 6.2% of their gross income and every employer contributes an additional 6.2% for each employee. Medicare is a government insurance plan that provides hospital, medical and surgical benefits for Americans 65 and older, and for people with certain disabilities. Every worker contributes 1.45% of their gross income to Medicare and every employer pays an additional 1.45% for each employee. If you see FICA on your pay stub, it stands for a law called the Federal Insurance Contributions Act, which requires employees to contribute to Social Security and Medicare with each paycheck.
Insurance:
If you have insurance through your employer, you are required to pay a portion of the plan premium. If you have any questions or concerns about your benefits, be sure to reach out to your human resources department.
Health Savings Accounts or Flexible Spending Accounts:
A flexible spending account allows you to set aside pre-tax dollars for medical expenses. Contributions to a flexible spending account are deducted from your pre-tax income. Health savings accounts are just another way to put pre-tax dollars aside for medical expenses. To be eligible for a health savings account, you need to select a high-deductible health insurance plan. Contributions to a health savings account are deducted from your pre-tax income.
Retirement Savings:
If you participate in your company’s 401(k) or 403(b) retirement plan, the percentage of your pre-tax pay that you choose to have withheld will be taken out of each paycheck and placed into a retirement account.
A regular review of your payroll deductions can help you identify any errors and get them addressed as quickly as possible. The last thing you want is for an error to be repeated through numerous pay periods. If you notice something unusual or have questions regarding your pay stub, reach out to your human resources department.
What do payroll taxes pay for?
The federal government levies payroll taxes on wages and uses most of the revenue to fund Social Security, Medicare, and other social insurance benefits. Federal income taxes also go towards things like defense and security.
State income taxes go towards a variety of areas, the most important being education and health care, as well as transportation, corrections, state police, parks and recreation.
Employee payroll taxes are usually made of these four taxes:
- Federal Income Tax
- State Income Tax
- Social Security
- Medicare
Employer payroll taxes are usually made up of these four taxes:
- Federal Unemployment Tax
- State Unemployment Tax
- Social Security
- Medicare
The amounts of these payroll taxes and what they pay for are highlighted in the table below.
Common Payroll Implementation Mistakes (and How to Avoid Them)
It’s one thing to shop around and look at different payroll providers. However, making the leap and actually implementing a new payroll system can be an overwhelming process. As a result, implementation mistakes are common and can sometimes sour relationships early on.
To ensure it’s smooth sailing from day one, we’ve highlighted some of the most common payroll implementation mistakes and how you can avoid them.
1. Lack of Planning
No matter how big or how small your company is, you need to have a plan in place before implementing your new payroll system. This involves tasks such as creating a timeline for the switch, identifying key stakeholders who will be impacted by the switch, ensuring that the right people will be available to facilitate the transition, and setting up training and support for those who will be using the new system.
For instance, if you have 20 employees and one payroll administrator, you’ll probably be okay handling the transition on your own. But if you have 4,000 employees across 20 payrolls, having one payroll specialist probably isn’t going to cut it. If you’re dealing with a significant amount of payroll data, you might consider bringing in a data analyst to carry out the data extraction, or a project manager to coordinate the switch.
When in doubt, you can always ask your new payroll provider what they recommend. In most cases, your new provider has carried out thousands of implementations, so they should be able to make recommendations for what is best for a team of your size.
2. Not Maintaining Data Integrity
In the immortal words of bookkeeper and Knit customer Sherri Lee-Mathers, “if you put garbage in, you’re going to get garbage out.” In other words, the kind of data you input into your new payroll system will influence what you get out. If the data is inaccurate from the start, it may become embedded in the system and result in significant errors over time.
To avoid the “garbage in, garbage out” scenario, it’s important to prepare your data well in advance. Before making the switch, take the time to:
- Audit your current data.
- Cleanse your data of anything you might not need anymore (keeping in mind that the CRA requires you to “keep all required records and supporting documents for a period of six years from the end of the last tax year they relate to”).
- Identify any missing payroll fields.
- Request any important documents from your current provider, such as copies of all Payroll Register Reports and copies of pay stubs for all employees.
While it may seem like a time-consuming process, taking the time to check for any inaccuracies or inconsistencies upfront will save you from countless errors down the line.
3. Not Customizing the Platform
For those unfamiliar with payroll processing or used to doing things manually, payroll software may seem like a kind of “one-size-fits-all” solution. In actuality, most payroll systems are extremely flexible and can be configured to fit your company’s exact needs. This means that companies that only work with the default settings are not getting the full benefits of the software.
To ensure that you are enjoying the full benefits of your new software, you should take the time to customize the platform to your company’s needs before you begin running payroll.
Statutory Payroll Tax Deductions
Statutory payroll tax deductions include the FICA (Federal Insurance Contributions Act) taxes. The FICA taxes consist of two separate taxes for Social Security and Medicare. Employees and employers both contribute to these federal payroll tax deductions, with each ponying up 6.2% for Social Security taxes and 1.45% for Medicare taxes.
Although you may feel a pang to see that money taken out of each paycheck, those deductions are the way workers pay into the Social Security and Medicare systems that eventually turn into Social Security benefits and Medicare coverage.
The biggest statutory payroll tax deduction is for the federal income taxes themselves. These are calculated according to each year’s payroll tax deductions chart. If you’re an employer who doesn’t have a computer system, payroll accountant or HR firm to do these calculations for you, you can seek out a payroll tax deductions online calculator or consult IRS guidelines.
Deductions can vary from year to year and are based on an employee’s salary and tax filing status (i.e. married vs. single). Employers may also deduct state and local taxes from employees’ earnings each pay period depending on whether the state, city or county require it. It’s the employer’s duty to collect the income tax that’s withheld, Social Security and Medicare taxes and send them to the IRS.