Category: Accounting

Everything You Need to Know About Payroll Deductions

Need information about the payroll deductions you see on every paycheck? Knowing what they are and why they exist is important for your understanding of your compensation. Knowing about payroll deductions lets you understand why your paycheck may not have been as much as you expected.

Payroll Deductions Are Mandatory or Voluntary

Payroll deductions are either mandatory or voluntary. Knowing the difference and why these deductions exist will explain why your salary is not the same as what you are paid. If you have additional questions after reading through this information, your Human Resources department is your best resource. They can answer your questions about your compensation, paycheck, and payroll deductions.

Mandatory Payroll Deductions

The employer is required by law to withhold payroll taxes from an employee’s gross pay prior to issuing a paycheck to comply with government regulations. Employers who fail to follow the law on mandatory deductions are open to lawsuits, fines, and even, going out of business.1

As an employee, you just need to understand what’s going on.

These are the mandatory payroll deductions for taxes:

• Federal income tax
• State taxes
• Local (city, county) income tax withholding in some areas. (Other local taxes can include school district taxes, community college taxes, state disability or unemployment insurance, for example.)2

The second set of mandatory payroll deductions are for FICA (Federal Insurance Contributions Act) taxes that include:

• Social security taxes and
• Medicare tax withholding.

Gross pay vs. net pay

Deductions and withholding make up the difference between gross pay and net pay. Gross pay is the total amount your employee earns from their salary or hourly wage plus any bonuses, commissions, and other forms of compensation. For example, if you pay employees twice a month, a salaried employee who makes $48,000 per year will earn $2,000 in gross wages each pay period. This gross pay is where most calculations start for the IRS’s “wages subject to withholding” for employee paychecks.

Some payroll withholdings are mandatory payroll taxes; other deductions are voluntary, meaning your employee has the option to not pay them. Many voluntary deductions like health insurance or 401(k) contributions are pre-tax deductions that have the effect of reducing an employee’s taxable gross pay. Once withholdings and deductions have been made, the remaining net pay is what you pay to your employees.

Withholding vs. Deductions

Withholdings and deductions are often treated as synonyms on your paystubs. Technically, though, the term withholding refers specifically to federal or state taxes that you take out of your employees’ paychecks and send to the government. All withholdings are mandatory.

Deductions are usually voluntary, and they include opt-in retirement savings, health insurance, or donations. There are also some involuntary deductions, like when wages are garnished to pay back taxes or child support. Some deductions are pre-tax, meaning they reduce your gross wages for tax calculations. Others are taken after taxes have been withheld. Don’t worry if this is confusing — we’ll take a closer look at specific deductions below.

Withholdings and deductions have two crucial elements in common: taking out the correct amount for each employee and then sending these funds to the proper tax agency or service provider.

The Deduction Types Commonly Used in Payroll

• Health Insurance – Medical, Dental and/or Vision health premiums are voluntary deductions that are held back from an employee’s paycheck, assuming that the employee is participating in the health insurance program. These can be spread out over the course of employment and deducted with each payroll, or deducted once a month.

• Short-term & Long-term Disability – If you provide your employees with Short-term & Long-term disability coverage, it ensures that your employees still receive a percentage of their salary in the event of an accident that leaves them disabled, temporarily or permanently. This deduction type would be used to collect employee premiums towards this insurance.

• Life Insurance – This deduction is used if an employer provides life insurance coverage, and your employees have signed up to receive basic term life insurance protection through the workplace. The premiums associated with the coverage are deducted from an employee’s pay, unless the employer is paying the premiums on behalf of the employee.

• Supplemental Life Insurance – Typically, company-sponsored life insurance plans tend to be pretty basic, one-size-fits-all type of plans. As such, your employees might want to get some additional life insurance coverage. If this supplemental insurance coverage is being purchased through the workplace, your employee gets the benefit of better rates (it’s not always guaranteed though), and this deduction type would be used to collect the premiums associated with this insurance.

• Dependent Life Insurance – This type of insurance coverage protects you in the case of a financial loss that results from the loss of a dependent spouse or child. If your employee is paying for this additional coverage, you can use this deduction type to deduct the premiums directly from an employee’s payroll.

• Accidental Death & Dismemberment (AD&D) – Based on the type of accidents that are covered in the plan, AD&D insurance gives your employees additional protection in the case of an accidental injury or death. The premiums for this type of coverage can be based on your salary or a specific set amount.

• 401(k) / Registered Retirement Savings Plan (RRSP) – If your employees want to put aside some money for their retirement, they can do that through a 401(k) / RRSP plan. This deduction type would be used to manage employee contributions if the amounts are being deducted directly from their payroll.

• Profit-Sharing – This type of a plan works as an excellent incentive to motivate and retain employees because it gives them a chance to really participate in the company’s financial success. Profit-sharing plans did not always include a component of employee contribution; however, this is becoming more commonplace. Employees have certain limits to the amount they can contribute towards a profit-sharing plan.

Payroll Deduction Plan Explained

Payroll deduction plans offer employees a convenient way to automatically contribute income toward an ongoing expense or investment. For example, it is common for employees to deduct a set percentage of income and contribute it to their traditional Individual Retirement Account (IRA) or Roth IRAs. An employee may also choose to have the premiums from an insurance policy deducted from their pay, ensuring that payment is never missed.

Some payroll deduction plans may also involve the voluntary, systematic payroll deductions to purchase shares of common stock. In such cases, the employee opts into their employer’s stock purchase plan and a portion each paycheck goes to buying shares of their employer’s stock, generally at a discounted price. In an example provided by the Securities and Exchange Commission (SEC) regarding the Employee Stock payroll Deduction Plan at Domino’s Pizza, Inc., eligible employees may opt to allocated 1-15% of their paycheck to buying company stock priced at 85% of fair market value of the date the option is exercised.

Accrue.

This means to build up or accumulate. As part of a compensation package, many employers offer paid vacation, sick, and personal time. There are many ways to provide this time. Often employers choose to allow the employee to earn (or accrue) a certain amount of time per pay period. Others may give a bulk amount at one time. 

ACH (Automated Clearing House).

This is an electronic network for processing direct deposits and other payroll transactions.

Base pay rate.

The rate that has been agreed upon to be the starting point for employee earnings. This can be an hourly rate, a daily rate, a piece rate, or salary per pay.

Deductions.

Deductions are amounts taken from the employee’s paycheck (not to be confused with taxes). These can be voluntary amounts that the employee chooses, such as health insurance premiums, retirement plan contributions, and miscellaneous deductions, or involuntary deductions, such as a child support order or a tax garnishment. These items can be considered pre-tax or post-tax, depending on the actual deduction.

EFTPS.

This stands for the Electronic Federal Tax Payment System. It’s used for an employer to pay federal taxes online.

Employee’s Withholding Allowance Certificate (W-4).

Federal Form W-4 or state equivalent is where the employee states the number of withholding allowances claimed to determine income taxes to withhold from the employee’s compensation.

Exempt.

Amounts that are not considered part of the taxable compensation. These amounts would be subtracted from the gross pay (total compensation) before the calculations of each applicable tax are completed.

Example:  Employee contributions to a 401(k) plan are considered exempt from federal income tax. The contribution amount for that paycheck is subtracted out before the calculation of the Federal Income Tax (FIT) is done.

Tax tricks that could save you thousands

Even though it’s still early to file your taxes, the sooner you crunch the numbers on your return, the better off you could be. The IRS issued more than 111.8 million refunds for the 2018 tax year, with taxpayers receiving an average payment of $2,869.

Boost retirement contributions

Contributing as much as you can to your retirement — via, for example, an individual retirement account — is one of the best ways to reap a tax benefit. “By contributing to an IRA, you directly reduce your taxable income and save for your retirement at the same time,”

Fund a health savings account

Another way to reduce your taxable income is to contribute to health savings account, or HSA. (You need what’s known as a high-deductible health plan to do this). And, you have until the April deadline to do so for the 2019 tax year.

“Health savings account contributions can reduce your income eligible for taxation, as well as help with planning future medical costs,” said. “That’s always a good thing for your personal finances in the long run.”

You can contribute up to $3,500 if you’re single.

The limit goes to $7,000 for couples and families.

You can add an extra $1,000, if you’re 55 or older.

Collect tax credits

Tax credits are particularly valuable because they reduce your tax bill on a dollar-for-dollar basis. For example, families can deduct up to $2,000 from their federal income taxes for each qualifying child under 17. If you qualify, that $2,000 child tax credit will save you $2,000 in taxes.

Tax Refund: Things To Do & Things Not To Do

Tax season is finally over, and millions of Americans will receive checks in the mail in the coming weeks from the IRS. Although I do some consulting and other independent work (which means that I don’t typically receive a tax return at all), my parents often received a very nice return (having a low income and a lot of dependents does that for you).

things not to do with your tax refund:

1. Buy lots of little frivolous things. Quite often, after getting a return, my parents would take the entire family out to dinner a few times. One year, they bought a Nintendo; another year, we got a giant new television when the old one was fine.

2. Get a new car. Income tax returns often meant automobile upgrades, even if the old one was still running fine.

3. Put the check directly into a checking account “for safekeeping.” This idea was heading in the right direction, except by putting it in the checking account, it didn’t earn anything, and over time it slowly was spent on all kinds of unnecessary things until it was gone.

4. Loan it to family members. Twice, the entire return was “loaned” to a family member who just simply never repaid the “loan.”

5. Have a giant party. At least one year, my parents had a giant spring party with tons of food and drink that ate almost all of their tax refund.

Even as a child, I knew that this probably wasn’t the best way to handle your tax return, and now as an adult, I can see even more clearly what you should be doing with a tax return.

Here are much better options for you to use your tax return on.

1. Start (or supplement) an emergency fund. Very few Americans have an adequate emergency fund – that is, a savings account somewhere that contains money that could be used for living expenses for several months in the event of a major crisis, like job loss. Sock the return away in a high interest savings account (like the one from ING Direct) and let it just sit there until disaster strikes. This way, the disaster won’t wreck your finances – you can just go withdraw the money and it’s taken care of.

2. Invest it in a mutual fund. We have a mutual fund going so we can have our dream house at some point in the future. This is a big part of our current reasoning in our house hunt – if we buy a less expensive home now, one we can easily make the 20% down payment on, we can continue to build this fund and eventually buy a much nicer home. This is a perfect option if you have a big long term goal, like a home, that’s far down the road.

3. Start (or supplement) a Roth IRA. If you need to kick retirement saving into high gear, look into starting a Roth IRA. It’s a great way to save money for retirement without any tax issues at all.

4. Seed your own business. Roll the money into things you could use to start a side business. Not only will you be able to deduct that money next year, but you’ll also lay the foundation for another income stream.

5. Put it in a 529 for your children. Use that money to lay the financial groundwork for your child’s college education. A 529 plan allows you to easily invest money with tax-free growth for educational expenses down the road.

6. Start (or supplement) a car fund. This doesn’t mean that you should go replace your car, but merely that you’re respecting the inevitable need to replace your current automobile.

7. Do a home improvement project. Roll that money right into new kitchen cabinets, a freshened-up bathroom, repainting some rooms, or a new carpet. Home improvement projects can increase the value of your home, which is especially important if you foresee a move in the coming years.

8. Make your living space more energy efficient. Replace all of your lightbulbs with CFLs, put in programmable thermostats, air seal your home, get a blanket for your water heater (if it needs one), and so forth. Doing these things all together can significantly reduce your monthly energy bill, meaning that in the long run the money you spent will become a tremendous investment with monthly dividends on your electric bill.

9. Buy an appliance that encourages eating at home. Similar to the energy efficiency idea, purchasing an appliance (like a deep freezer or a stand mixer) that can encourage you to eat at home more often will gradually reap rewards over time, as you begin to prepare food at home. A deep freezer is one of the first investments we plan on making when we have our own home, because we can prepare many meals well in advance and merely pull them out and toss them in the oven in the evening.

10. Buy individual stocks. You could even take the money and start an individual stock investment account. This is a good way to get very familiar with the stock market and individual stock investing, though it is not something I actively pursue at this point. Remember, though, that individual stock investing carries substantial risk – but has the potential for substantial reward.

Lodging a tax return

Lodge online for free with myTax

You can lodge your return using myTax, the ATO’s free online tool. You need a account linked to the ATO to lodge online. Returns lodged through are usually processed within two weeks. Lodging online with myTax is easy. Most information from employers, banks, government agencies and health funds will be pre-filled into your myTax by mid-August. You just have to check the information, enter any deductions you have, and submit. MyTax will then calculate your tax for you.

Declare all your income

Most of the information about your income will be pre-filled from details the ATO receives from your employer and financial institutions. There may be other income you need to add yourself.

Common types of income that must be declared includes:

employment income

government payments

super pensions and annuities

investment income (including interest, dividends, rent and capital gains)

income from the sharing economy (for example Uber or Airbnb)

compensation and insurance payments

Work-related expenses

To claim a deduction for work-related expenses:

you must have spent the money yourself and not been reimbursed

it must be directly related to earning your income

you must have a record to prove you paid for it

When your expenses meet these criteria, here’s a list of the things you may be able to claim.

Vehicle and travel expenses — If you use your car for work or work in different locations, then you may be able to claim a deduction. This does not normally include the cost of travel between work and home.

Clothing, laundry and dry-cleaning expenses — To claim the cost of a work uniform, it needs to be unique and distinctive. For example it contains your employer’s logo, or is specific to your occupation, like chef’s pants or coloured safety vests.

Self-education expenses — If the study relates to your current job, you can claim expenses like course fees, student union fees, textbooks, stationery, internet, home office expenses, professional journals and some travel.

Tools and other equipment — If you buy tools or equipment to help earn your income, you can claim a deduction for some or all of the cost. Examples include protective gear, including sunscreen, sunglasses and hats if you work outside.

When tax prep is free, you may be paying with your privacy

So this tax season, I started asking why, exactly, all those “free” online tax services are free. One used by more than a million Americans had an alarming answer: Credit Karma Tax takes the intimate details of your tax returns — like how much you earn and pay for your mortgage — to target you with financial advertising.

You probably already suspected that products such as Intuit’s TurboTax and H&R Block offer limited free service as bait to sell you fancier paid services. Then there are a dozen free, no-upsell services run pro bono by the tax-prep industry — but only for people who earn less than $66,000 per year. (Dubbed “Free File,” these services are often buried; you can find them linked directly on the Internal Revenue Service website.)

A third kind of free tax prep, offered by Credit Karma, is blazing a new path: paying with your privacy. Available since 2017, Credit Karma Tax is an extension of the credit score website that’s already used by 85 million people. The tax service is really free — even if you use complicated IRS forms. It makes money by showing you tailored “offers” for credit cards and loans based on a profile of your financial life, which includes your tax returns unless you adjust a setting to opt out.

Credit to Credit Karma’s CEO Kenneth Lin: He spoke openly with me about his business. One reason Credit Karma got into the tax game, he said, is because it rounds out the data it needs to determine when customers might be eligible for, say, a new personal loan. Credit Karma can make between tens and hundreds of dollars each time someone accepts one of its loan or card offers — and the more accurately it can target us, the more money it makes.

There’s a fine line between useful and creepy with surveillance. For some, Credit Karma’s offers might be acceptable, even time- and money-saving. To me, Credit Karma Tax is taking a business idea that hasn’t worked out well for us with Facebook and applying it to even more sensitive information

Tax time: what you need to know before filing your student tax return

Chances are that as a student, you’re focused more on acing finals or planning a ski trip than filing taxes. You may even believe that as a full-time university student you’re exempt from paying taxes.

Claim your tuition credits.

students currently enrolled in a college or university can claim tax credits for tuition fees (any course that costs more than $100) and examination fees for licensing and certification.

Deduct student loan interest.

As a student, you can claim a non-refundable tax credit based on the interest you’ve paid on government student loans. If you don’t need the deduction, Waterman says you can carry the tax credit for student loan interest forward for up to five years and claim it on future returns after you’ve completed your studies.

Considerations for International Students.

If you’re studying, but it isn’t your home country, you may still need to file a tax return based on any earnings received from working as a teaching assistant, tutor, or from taxable scholarships.

Think about moving expenses.

Have you transferred from one university to another this past year or moved at least 40 kilometres closer to your school? If so, you may be eligible to deduct moving expenses such as transportation and storage costs, temporary living expenses, and incidental costs (utility hook-ups, etc).