Pre-tax Deduction

Some deductions from an employee's payroll are subtracted first before computing the taxes that need to be withheld. Here’s what you need to know about pre-tax deductions. 

What Is A Pre-tax Deduction?

A pre-tax deduction is the amount deducted from an employee’s gross compensation before taxes are withheld. Pre-tax deductions therefore reduce the employee’s taxable income. 

Are Pre-tax Deductions The Same as Payroll Deductions?

While both reduce the employee’s take home pay (net income), pre-tax deductions are not the same as payroll deductions. 

Payroll deductions include taxes, benefits, levies, garnishments, and other contributions taken from the employee’s compensation before or after taxes. pre-tax deductions are taken before taxes. 

Hence, all pre-tax deductions are considered payroll deductions, but not all payroll deductions are pre-tax. 

Pre-tax vs Post Tax Deductions

Unlike pre-tax deductions, post tax deductions do not affect the amount of income that the employee has to pay taxes on. This is because they are subtracted after taxes are withheld. 

What Are Examples Of Pre-tax Deductions? 

The law defines what should be included in the list, but generally the following may qualify as pre-tax deductions:

  • Health Insurances, particularly those that are employer-sponsored with medical and dental benefits. 
  • Health Savings Account 
  • Life Insurance premiums. However, there might be a limit. In the US, only a coverage of up to $50,000 may be qualified as a pre-tax deduction. 
  • Retirement Funds and Pension Scheme
  • Transportation Benefits, including commuter allowances, transport passes, and parking fees. 

To be sure of what deductions are included in the list, it’s best to consult your legal team. pre-tax deductions may vary depending on where your business is located. For example, in the Philippines, the non-taxable deductions include Social Security System (pension scheme), PhilHealth (health insurance), and PAGIBIG (national savings program) contributions. If the employer deducts for tardiness and absences, then those are pre-tax deductions as well. 

Please also check if pre-tax deductions change yearly based on factors such as inflation and cost of living. 

The Benefits Of Pre-tax Deductions

pre-tax deductions have two primary benefits for employees:

It helps employees save more money

Pre-tax deduction plan gives employees more coverage when it comes to important benefits, including life and health insurances. Deducting it before taxes usually means they’ll spend less than if they decide to pay for it privately after all payroll deductions. 

It lowers their taxable income

pre-tax deductions lower the employee’s tax burden because they reduce the taxable income. Since the money is subtracted before taxes are withheld, there will be less amount subject to tax withholding. 

Pre-tax Deductions Example

To better demonstrate how a pre-tax deduction works, here’s an example:

An employee receives a gross income of $1750 biweekly. Their total pre-tax deduction is $110. This means taxes can only be withheld from $1750-$110= $1640. 

Is It Possible For Employees To Waive Pre-tax Deductions?

Employees sometimes want to waive their pre-tax deductions and choose to pay after taxes. Two possible reasons for this are:

  • Social Security Retirement Benefit. Because of pre-tax deductions, the amount of income used to compute for the Social Security retirement benefit becomes smaller. However, please note that in most cases, the amount of money employees save from pre-tax deductions are higher compared to the benefit of waiving them. 
  • Unemployment. pre-tax deductions likewise reduce the amount of income used to calculate the unemployment benefit. Hence, some employees may waive them and instead pay post-taxes. 

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