What Items Are Not Included as a Payroll Deduction?

Payroll deductions are amounts taken from an employee’s paycheck for taxes, benefits, and other obligations. While many items can be deducted, some payments or benefits are handled separately. Understanding these exclusions helps both employees and employers manage compensation correctly.

Some payments are reimbursed rather than deducted, while others involve direct employer contributions or third-party transactions. Knowing the difference ensures compliance with tax laws and prevents confusion about take-home pay.

Reimbursements for Business Expenses

When employees pay for work-related costs out of pocket, employers often reimburse them instead of deducting amounts from their paycheck. These reimbursements are not taxable income if they follow an accountable plan, which requires documentation, returning excess funds, and ensuring costs are business-related. If an employer provides a flat allowance without requiring receipts, the payment may be taxable.

Common reimbursable expenses include travel costs such as airfare, lodging, and meals. The IRS allows per diem rates for meals and lodging, simplifying reimbursement by providing a fixed daily amount instead of requiring receipts. For 2024, the standard per diem rate for travel within the continental U.S. is $166 for meals and $107 for lodging, though some locations may have higher rates. Mileage reimbursement for personal vehicle use is another frequent expense, with the IRS setting the 2024 rate at 67 cents per mile.

Employers may also reimburse office supplies, client entertainment, and professional development costs. If an employee buys software or equipment necessary for their job, the employer can repay them without tax consequences, provided ownership remains with the company. If the employee keeps the item for personal use, the reimbursement could be taxable.

Employer-Provided Benefits That Require No Withholding

Certain employer-provided benefits are not subject to payroll tax withholding because they are either excluded from taxable income under IRS regulations or fall below specific thresholds. These benefits enhance compensation without increasing tax liability.

Health insurance premiums paid by an employer for an employee’s coverage, including medical, dental, and vision plans, are generally exempt from federal income tax, Social Security, and Medicare withholding. This exclusion applies if the plan is structured under Section 125 of the Internal Revenue Code, commonly known as a cafeteria plan. Employer contributions to Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) also qualify for tax-free treatment, provided they adhere to annual contribution limits—$4,150 for individual HSAs and $8,300 for family coverage in 2024.

Retirement plan contributions made by an employer to a qualified plan, such as a 401(k) or 403(b), are not taxed when contributed. These amounts are only taxed when withdrawn in retirement. Employer matches and profit-sharing contributions follow the same deferral rules, allowing employees to grow their savings without immediate tax consequences.

Employers can also provide up to $5,250 annually in tax-free tuition reimbursement under Section 127 of the Internal Revenue Code. If the benefit exceeds this threshold, the excess amount becomes taxable unless it qualifies as a working-condition fringe benefit, which requires the education to maintain or improve job-related skills.

Transportation benefits, including employer-provided transit passes and parking subsidies, are another category of non-taxable perks. Under Section 132(f), employees can receive up to $315 per month in tax-free commuter benefits for public transit or parking in 2024. Any amount above this limit is taxable.

Personal Expenses Paid Separately

Some costs fall outside payroll deductions because they are personal and must be handled directly by employees.

For example, individual insurance policies—such as supplemental life, disability, or long-term care coverage purchased independently—do not qualify for automatic payroll withholding unless arranged through an employer-sponsored plan. Employees who obtain these policies on their own must manage payments directly with the insurer.

Similarly, personal loan repayments, including credit card bills, mortgages, and auto loans, are financial commitments employees must address outside of payroll. Employers have no legal role in facilitating such payments unless ordered by a court.

Charitable donations are another example. While some employers offer payroll deduction programs for charitable giving, these are voluntary. Employees who donate independently must track contributions for tax purposes, as only donations to qualified 501(c)(3) nonprofits may be deductible when itemizing deductions on a federal tax return.

Direct Payments to Third Parties

Some financial obligations are settled directly by an employer on behalf of an employee rather than being deducted from wages. These payments bypass payroll entirely and do not reduce taxable income or appear on pay stubs.

Court-ordered wage garnishments, such as child support or alimony, are one example. Employers may be legally required to remit these payments directly to government agencies or recipients under garnishment orders. Federal law under the Consumer Credit Protection Act (CCPA) caps most wage garnishments at 50% to 65% of an employee’s disposable earnings, depending on support obligations. Unlike voluntary payroll deductions, these payments are withheld under legal mandate.

Union dues and professional association fees are another example. While many employers facilitate payroll deductions for these payments, others handle them separately by remitting lump sums to unions or trade organizations based on collective bargaining agreements. If an employer covers these fees as a condition of employment, the payments may be considered a business expense rather than employee income.

Non-Compensation Rewards

Some employer-provided benefits do not qualify as payroll deductions because they are not considered direct compensation. These rewards often serve as incentives, perks, or acknowledgments of employee contributions but are handled separately from wages.

Employee achievement awards, such as service milestones or safety recognitions, can be excluded from taxable income if they meet IRS guidelines under Section 274(j). To qualify, awards must be tangible personal property—such as a watch or plaque—rather than cash or gift cards, and they must be part of a meaningful awards program. The tax-free limit for these awards is $1,600 annually for qualified plans and $400 for non-qualified plans. If an award exceeds these thresholds or does not meet eligibility criteria, the excess amount is taxable.

Employer-provided de minimis benefits include occasional perks of minimal value that are impractical to track for tax purposes. Examples include holiday gifts (excluding cash), occasional meals, and limited personal use of company resources. The IRS does not specify a strict dollar limit for de minimis benefits, but they must be infrequent and low in value. If an employer provides a benefit regularly or at a significant cost, it may become taxable compensation.

Non-Qualified Stock Options

Stock options allow employees to purchase company shares at a predetermined price. While qualified stock options, such as Incentive Stock Options (ISOs), receive favorable tax treatment, non-qualified stock options (NSOs) do not and are subject to different tax rules. These options are not deducted from payroll but create taxable events when exercised.

When an employee exercises NSOs, the difference between the exercise price and the fair market value of the stock on that date—known as the bargain element—is treated as ordinary income. This amount is subject to federal income tax, Social Security, and Medicare withholding, even though it is not deducted from regular wages. Employers must report the taxable income on Form W-2, and employees are responsible for paying any additional tax owed when filing their return.

If the employee later sells the stock, any further gain or loss is treated as a capital transaction. The holding period determines whether the gain is taxed as a short-term or long-term capital gain, with long-term rates generally being more favorable. Unlike ISOs, which can defer taxation until the stock is sold, NSOs trigger immediate tax liability upon exercise, making tax planning an important consideration for employees receiving this type of equity compensation.