Determining which employee deductions can be pre-taxed for Social Security, Medicare, federal withholding and state withholding can be difficult to discern. First and foremost, for any deduction to be eligible for pre-tax status, the employer must have the appropriate plan document(s) on file.
Determining which employee deductions can be pre-taxed for Social Security, Medicare, federal withholding and state withholding can be difficult to discern.
First and foremost, for any deduction to be eligible for pre-tax status, the employer must have the appropriate plan document(s) on file. A 401(k) plan document and/or Section 125 plan document is required in order for the employer to pre-tax any deductions for their employees.
Once the appropriate documents are in place, the question then becomes which deductions are eligible for pre-tax status. Retirement plans are, for the most part, straightforward and allow employees to withhold contributions before federal and state withholdings are calculated. Social Security and Medicare, however, are not excluded.
The more complex questions concern the different health deductions that an employee may have. The simple answer is: it all depends on the employer’s Section 125 (Cafeteria Plan) document. That document should clearly define what deductions are eligible for pre-tax status. Deductions that are eligible per the plan document are excluded from income before any taxes are calculated (Social Security, Medicare, Federal and State). Without a current plan document, the employer may not take any deductions on a pre-tax basis.
The most common pre-tax deductions outlined in the document are:
- Group health insurance (including dental and vision)
- Health flexible spending accounts
- Dependent care assistance programs
- Health Savings Accounts
Beware of pre-taxing Short-Term and Long-Term Disability deductions! Even though the employer can allow these deductions to be pre-taxed, should the employee ever use the benefit, the benefit payments will be taxable. If the deductions are taken on a post-tax basis, however, benefit payments are generally not taxable to the employee.
Different supplemental policies can also be confusing (such as AFLAC, Colonial, etc.). Some are eligible for pre-tax status, like accident and cancer policies, while others are not. For example, life policies are typically not eligible.
Before setting up any deductions for your employees, always check with your payroll provider about what deductions may be eligible for pre-tax status. They should help walk you through the process of checking your plan document(s) and getting you set up properly. If you process your own payroll, carefully review all plan document(s) to ensure you are pre-taxing only those deductions that are specifically listed.