|An employee's pay is one area of
a business that has no tolerance for errors. Not only must you
properly calculate the employees earnings but also properly
calculate all the deductions that apply to your employee's
earnings. What many employers may not realize is that federal and
state laws may apply to what and how much can be deducted from an
Although not always
required by law, a good practice is to have a "blanket"
signed authorization form from all your employees authorizing what
deductions may be taken from their pay and the circumstances that
"trigger" the deduction. In addition, all new hires should not only
sign the "blanket" deduction authorization but be given an oral
briefing about your policy and have a chance to clear up any
questions or misunderstandings right from the start. In addition to
your "blanket" authorization, you should also have specific
authorization forms for the different types of deductions
initiating and terminating any deduction. An example of a specific
deduction form would be one authorizing the employer to deduct the
employee's share of medical insurance from their pay including the
starting or ending dates. Of course, you would want these forms
also signed by your employees.
For employers that offer and
provide a lot of fringe benefits to their employees, many of the
deductions from an employee's wages are directly related to the
fringe benefits. In many cases, the employer pays a portion of the
cost and the employee also is required to pay a portion of the
cost. The employee's portion of the cost is normally deducted from
- Basically deductions from pay can be classified into
- Deductions Required by
- Deductions for the Employer's
- Deductions for the Employee's
Required by law
- Social Security- mandatory
"contributions" to the federal retirement system.
The Social Security deduction is calculated as the employee's gross
earnings times 6.2%. For 2005, incomes over $90,000 that have
already had the maximum Social Security amount of $5580.00
withheld will not have any additional Social Security
- Medicare- mandatory
"contributions" to the federal medical system.
The Medicare deduction is calculated as the employee's gross
earnings times 1.45%. Unlike Social Security there is no annual
limit to Medicare deductions.
- Income Tax Withholdings- pay as
you go deductions for income tax.
The IRS supplies approved tables, methods, and instructions on
calculating how much should be deducted from an employee's
- State Income Tax Withholdings-
pay as you go deductions for state income tax.
Most but not all states have a state income tax. State taxing
authorities supply approved tables, methods, and instructions on
calculating how much should be deducted from an employee's
- Local Income Tax Withholdings-
pay as you go deductions for local income tax.
Some but not all local governments have a local income tax. The
local taxing authority supplies approved tables, methods, and
instructions on calculating how much should be deducted from an
Note: Employees may
authorize an additional amount that they want withheld from
their pay for income, state, or local taxes. Why would anyone do
this ? Some people want to make sure that when they settle up with
the government agencies after the end of the year, they don't owe
any additional money or are getting a refund. In other cases,
employees may have other sources of earnings on which no taxes are
being withheld and they use this extra withholding to cover the
taxes on those earnings.
- Garnishments and Child Support-
deductions to satisfy legal claims of others for unpaid obligations
of an employee.
Note: Special rules and calculations are required in order
to determine the amount of the allowable deduction.
- Tip Credits - allow an employer,
when allowed by federal and state laws, to pay employee's in tip
related occupations less than minimum wage. The amount of the
current tip "credit" is $3.02 which allows an employer to only have
to pay a direct wage rate of $2.13 per hour ($5.15 - 3.02).
Note:If your an employer in this type of industry consult
the applicable federal and state labor laws.
Be Careful on deductions that fall within this category. As a
general rule, any deductions of this type can not reduce the
employee's gross pay below the minimum wage. Federal and/or State
labor laws govern how much if any can be deducted from an
employee's pay. You may not try to "get around the law" by having
the employee reimburse the employer in cash for the cost of such
items in lieu of deducting the cost from the employee's wages. All
the deductions below if authorized by the employee and they don't
violate any federal or state laws are normally an allowable
deduction. The only employee's that you actually need to worry
about are your lower wage rate employees.
- Over payments- errors made in
calculating employees wages. Although you'll normally be able to
deduct for over payment errors you need to exercise caution when
the over payment is made to your lower paid employees.
- Tools- required tools necessary
for performing the employee's job.
- Uniforms- deductions for uniforms
required by law or the employer and any related cleaning of the
- Shortages- deductions for cash or
other shortages attributable to employees. In the restaurant and
bar business many employers also try to hold their employees
accountable for customer walkouts (leave without paying their
- Breakage- deductions for
merchandise damage attributable to improper or careless handling by
- Medical exam -deductions for
employee medical exams required by employer or law.
- Drug test - deductions for drug
test required by law or the employer.
- Employee theft - deductions for
cash or merchandise shortages attributable to employees.
Common senses would dictate that if an employee stole from me, I
should be able to recover the amount from any pay that I owe to the
employee. This is not always the case and you should probably
consult with an attorney prior to deducting any employee theft
losses from their wages.
- Insurance-the employee's
share of Group Life and Medical & Dental insurance when the
employer does not cover 100 % of the premiums.
Warning:Care should be exercised and procedures set up to
ensure that employee's who are supposed to be covered are actually
covered and that all premiums deducted along with any required
employer contributions are timely remitted to the insurance
carriers so that the policy doesn't lapse and you as an employer
become liable for unpaid employee medical or insurance
- Advances / Employee Loans-
occasionally an employee may have an emergency and the employer
approves an advance and the employee authorizes his/her employer to
deduct the advance or loan from his/her wages.
Note: Although it's great for employers to help out
employees during emergencies, the employer does not want loans and
advances to become the rule rather than the exception. It's
probably wise to have a policy governing what situations are
eligible for an advance or loan.
- Retirement Plan- deductions for
the employee's portion of contributions to employer sponsored
- Union Dues - deductions approved
by employees that provide for the payment of the employee's union
- Charity-United Way - authorized
deductions by the employee that enable the employer to deduct and
forward specified amounts to the employee's choice of
- Employee-Savings Accounts / U.S.
Bonds - authorized deductions by the employee that enable the
employer to deduct a specified amount used to fund a savings
account or purchase a bond on the employee's behalf when the total
accumulated deduction reaches the amount needed to purchase the
employee specified bond amount.
A few examples should help give
you a better idea of some instances where you as an employer may
want to seek some professional guidance before deducting from an
employee's pay. As stated earlier, normally the determination of
whether you as an employer can legally deduct an employer's
convenience type item from an employee's wages depends on whether
the deduction will result in the employee being paid less than
(1) A minimum wage employee
working as a cashier is required by the employer to reimburse the
employer for a cash drawer shortage.
(2) An employer has a "policy"
requiring tipped employees to pay for customers who walk out
without paying their bills.
(3) An employer requires minimum
wage employees to have uniforms and deducts the cost of the
uniforms from their pay.
(4) An employee wrecks a company
vehicle and the employer holds the employee responsible and deducts
the non-reimbursed cost of the repairs from the employee's wages
resulting in wages paid below the minimum wage.
(5) The cost of an
employer-required physical examination or drug test cuts into an
employee's minimum wage or overtime compensation.
In addition, some deductions such
as employee contributions to retirement and health insurance
plans are subject to special rules and may qualify for
favorable tax treatment. We'll discuss this more in Lesson 3 -
||This lesson classified the types
of deductions into three major categories and also illustrated that
while most deductions are "straightforward", some deductions may at
times have some complicating factors thrown in and be subject to
It's still too early in this
tutorial to fall asleep on me. On to our next lesson, Calculating
Payroll, where the calculations involving Types Of
Compensation (Lesson 1) and Types of Deductions (Lesson
2) are illustrated and explained.