There are several elements involved while processing payroll, including withholding, submitting, and managing different types of payroll deductions, all of which are complex activities that must be done with utmost precision.
As a business owner, most times, you must deposit and report payroll taxes periodically. Payroll deductions include deductions from employees’ salaries that covers the national, state and regional income taxes and the employee’s part of the social services and medical care.
An important part of payroll deduction also includes the employer’s part of contribution of social services and Medicare which is called EPF (Employee provident fund) and EPS (Employee pension scheme) in India, FICA contribution in the US. Failing to withhold and deposit taxes can lead to not just fines but non-compliance, that can cause more problems to the reputation of the brand.
What is Payroll Deduction?
Payroll deduction refers to the deduction of some amount from an employee’s salary like taxes and incentives of different forms. The different types of standard payroll deductions include voluntary and mandatory contributions.
An example of involuntary deduction is the EPF (Employee provident fund), which is deducted as part of Social Security and Medical care. Voluntary payroll, on the other hand, is a deduction that is made with the permission of the employee, such as for a pension scheme or other medical care or insurance payments.
Payroll deductions are of various types. Let’s see what the different types of payroll deductions are, in detail.
What are the Different Types of Payroll Deductions?
There are different types of payroll deductions, some are voluntary, and some are mandatory payroll deductions. The three most common types of payroll deductions are:
1. Pre-tax deductions
A pre-tax deduction is simply an amount deducted from the overall salary (gross pay) of an employee before any taxes are withheld. Gross pay is the income before deduction of taxes.
Why and how are pre-tax deductions good for an employee?
These amounts deducted are non-taxable. Aside from being non-taxable, they reduce the gross earnings of an employee which is good, because it helps lower the amount they have to pay towards the government in the form of taxes.
Examples of pre-tax deductions are:
- Health insurance
- Life insurance
- Pension fund
Pre-tax deductions are usually optional. But most employees, if not all, avail them, as they are beneficial for them since they reduce their taxable income and get an increased take-home pay. The number of pre-deductions that can be claimed by an is regulated by the Indian Revenue Services (IRS).
2. Statutory payroll deductions
Statutory deductions are mandatory payroll deductions that employers must withhold from the employee’s salary as part of taxes to be paid to the government. These tax amounts are used by the government towards public services. This includes-
- the federal income tax or EPF, deducted from a person’s salary based on the amount they earn.
- state income tax depending on the specific state income tax laws, if any
- Voluntary taxes made towards social security, medical care, pension scheme etc.
3. Post tax deductions
Post tax deductions are taxes that are withheld after all the statutory tax deductions have been processed. In simpler terms, they are a certain amount taken from the employee’s net pay and not the gross pay.
Examples of post-tax deductions
- Union dues- for individuals under the labour union
- Wage garnishments- mostly ordered from courts or other regulatory bodies to cover unpaid taxes, child support payments, alimony etc.
- Retirement contributions
- Donations- philanthropic contributions made by an employee through workplace giving programs or payroll deductions
- Insurance premiums- Contributions made in case an employee opts for additional coverage.
How do Payroll Deductions Work?
Payroll deductions may be voluntary and involuntary but either way, they are present to help employees with an option to contribute money to a recurring deposit, more or less like a savings account.
While voluntary deductions are made as per the employee’s choice for their personal needs and requirements like medical care, health insurance etc, the latter are taxes deducted from the gross pay and reducing the total gross pay to help reduce the payable tax amount by employees and end up with a handsome in-hand pay (net pay). Employees, for example, can allow employers to deduct a certain amount from their earnings and invest it in stocks, they can elect to have insurance premiums etc, ensuring safety.
How to Calculate Payroll Deductions?
Payroll deductions are calculated by considering 4 main components- Basic Pay, Allowances, deductions, and IT declarations. By using an employee payroll deduction calculator we can streamline this process, ensuring exact calculations for every employee’s earnings, taxes and net pay.
Below is a list of formulas to calculate payroll tax deductions for employees.
1. Gross pay
Sum of Basic pay+ allowances
2. Net Pay
Gross pay- (Deductions+ TDS)
Total TDS is the sum of TDS, Surcharge, Health and Education cess.
3. HRA
The amount received as the HRA from the employer. Actual rent paid less 10% of the basic salary and 50% of the basic salary if staying in a metro city and 40% in a non-metro city.
4. Provident Fund
PF deduction (Provident Fund) is calculated on 12% of Basic + PF applicable allowances.
5. Employee State Insurance
ESI is calculated on 0.75% of Gross Pay (Basic and ESI applicable allowances)
Examples of Payroll Deductions
Like we have mentioned before, payroll deductions are of different types. According to the payroll deduction policy, some amount is deducted from an employee’s salary by the employers which includes taxes that is payable to certain government bodies and amount voluntarily allowed by an employee to be deducted from their salary for their own benefit as a recurring deposit.
Examples of payroll deductions are-
- Income tax
- Insurance premiums
- Wage garnishments
- Professional tax holdings
- Employee provident fund
- Employee pension scheme
- Childcare
- Disability insurance
- Health insurance
- State unemployment insurance
- Retirement plans
- Spouse life insurance
- Medical care
What are the Components of Payroll?
The payroll process has a list of components that needs to be considered. Every detail of processing payroll must be accurately marked up according to local laws. Any mistakes during processing of payroll can lead to non-compliance. So, let’s take a closer look at those components-
1. Employee Information
This is certain information you must collect from each employee before paying them. In India, employees are required to complete Form 16 at the time of the hiring. The form 16 has information about the employees’ income tax deductions along with other personal information like their name, address, social security number etc.
2. Wages and Salaries
Every company has a unique pay policy and is subject to local laws. Whether it is regarding overtime pay, attendance policies, leaves, benefits, and allowances, they have the freedom to design the rules and regulations as per their need. The yearly statement of the employee may include gross salary, overtime compensation, time spent, reimbursements and perks payments, net pay, and other earnings.
Voluntary vs Involuntary Deductions: What is the Difference?
Payroll deductions is an amount that is subtracted from the gross pay of an employee based on established rates as well as employee requirements for voluntary deductions. Payroll deductions are of two types:
- Voluntary deductions
- Involuntary deductions
Let’s map out the difference between the two that will give you a clear understanding of all types of payroll deductions.
1. Voluntary deductions
Voluntary deductions are sums of money which an employee elects to have reduced from their gross pay towards their personal needs like life insurance, healthcare benefits or other benefits deductions. Voluntary deductions can be taken from an employee’s salary as pre-tax deduction, post-tax deduction or a tax deferred deduction. If an employee wishes to make any changes or alter voluntary deductions, they must contact the office much prior to payroll processing day to ensure the office has the time to make the necessary changes.
Examples of voluntary deductions are-
- Contributions made towards a pension scheme
- Health care coverage
- Education
2. Involuntary deductions
Involuntary deductions include Garnishments and taxes.
Garnishments are the amounts that are mandated by federal or state law to be withheld from an employee’s pay that they are obligated to pay according to state laws and regulations. Examples include-
- Federal income tax
- State tax
- County or city tax levies
- Court ordered child support payments, or court ordered bankruptcy.
In India, federal income taxes and state taxes are in the form of- EPF, ESI, TDS etc, County or city tax levies, Court ordered child support payments, or court ordered bankruptcy fall under wage garnishments.
How can Alp Consulting Help?
It’s essential for a business to understand about different types of payroll deductions. It will help organizations build an accurate, efficient payroll process that complies with the requirements in your jurisdiction(s). The entire payroll process can be quite tedious, and as your company grows the complexity of the process increases as well. This is when you should consider engaging the professionals.
Alp Consulting, being one of the most reputed payroll service providers in India, provides professional payroll services as it houses payroll experts who understand the in and out of payroll. They help process pay checks on your behalf can give you peace of mind and allow you to focus on what you do best — running your business. Contact us today and we’ll hook you up with the right payroll solution for your organization.
