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Types Of Deductions

Payroll Basics > Types Of Deductions
Payroll Deductions
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 employee's pay.
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 their wages.

Deductions From Pay
Basically deductions from pay can be classified into three categories:

  • Deductions Required by Law
  • Deductions for the Employer's Convenience
  • Deductions for the Employee's Convenience
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 2020, incomes over $137,700 that have already had the maximum Social Security amount of $8537 withheld will not have any additional Social Security withholdings. The maximum increases to $142,800 in 2021.
  • 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 pay.
  • 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 pay.
  • 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 employee's pay.

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.
    Note:If your an employer in this type of industry consult the applicable federal and state labor laws.

Employer's Convenience
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 uniforms.
  • 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 bill).
  • Breakage- deductions for merchandise damage attributable to improper or careless handling by employees.
  • 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.

Employee's Convenience
  • 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 claims.
  • 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 retirement plans.
  • Union Dues - deductions approved by employees that provide for the payment of the employee's union membership dues.
  • Charity-United Way - authorized deductions by the employee that enable the employer to deduct and forward specified amounts to the employee's choice of charities.
  • 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 minimum wage.

(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.

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 special rules.

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