What Payroll Deductions Are Pre-Tax?

Payroll deductions represent amounts subtracted from an employee’s gross pay, impacting the final take-home amount. “Pre-tax” deductions are unique because they are subtracted from an employee’s earnings before certain taxes are calculated.

Understanding Pre-Tax Deductions

Pre-tax deductions operate by reducing an employee’s gross wages before federal income tax, state income tax (where applicable), and sometimes FICA taxes (Social Security and Medicare) are computed. This means the amount deducted is not considered part of the employee’s taxable income for those specific taxes, leading to a lower overall tax liability. For example, if an employee earns $1,000 and has a $100 pre-tax deduction, their taxable income for relevant taxes becomes $900, rather than the full $1,000.

The key distinction between pre-tax and post-tax deductions lies in their timing relative to tax calculation. Post-tax deductions, such as Roth 401(k) contributions or certain garnishments, are withheld from an employee’s pay after all applicable taxes have been calculated and subtracted. This difference means post-tax deductions do not reduce an employee’s current taxable income, although they may offer tax benefits in the future, as with Roth accounts. The pre-tax approach lowers an individual’s adjusted gross income, which can also influence eligibility for certain tax credits or deductions.

Common Types of Pre-Tax Deductions

Health insurance premiums are deducted from an employee’s gross pay before income taxes are calculated, provided they are part of an employer-sponsored group health plan. This reduces taxable income for federal, state, and FICA taxes.

Contributions to employer-sponsored retirement plans, such as 401(k), 403(b), or 457(b) plans, are also common pre-tax deductions. These contributions reduce an employee’s taxable income for federal and state income taxes in the current year, though they remain subject to FICA taxes. For 2024, the contribution limit for most employees to 401(k) and 403(b) plans is $23,000, with an additional catch-up contribution of $7,500 for those aged 50 and over. This deferral of income tax until retirement allows the contributions and their earnings to grow tax-deferred over time.

Flexible Spending Accounts (FSAs) for healthcare and dependent care offer tax savings on eligible expenses. Healthcare FSAs allow employees to set aside pre-tax money for medical, dental, and vision expenses not covered by insurance, with a maximum contribution of $3,200 for 2024. Dependent Care FSAs, capped at $5,000 per household for 2024, cover expenses like daycare or after-school care for qualifying dependents. Both types of FSAs are exempt from federal income tax, state income tax, and FICA taxes.

Health Savings Accounts (HSAs) are advantageous pre-tax deductions available to individuals enrolled in a high-deductible health plan (HDHP). Contributions to an HSA are pre-tax, grow tax-free, and can be withdrawn tax-free for qualified medical expenses. For 2024, the maximum contribution is $4,150 for self-only coverage and $8,300 for family coverage, with an additional $1,000 catch-up contribution for those aged 55 and over. Unlike FSAs, HSA funds roll over year to year and are portable, remaining with the individual even if they change employers.

Commuter benefits, such as qualified transportation benefits, also fall under pre-tax deductions. These benefits allow employees to use pre-tax income for mass transit passes or parking expenses related to their commute. For 2024, the monthly limit for both transit passes and qualified parking is $315. These amounts are excluded from an employee’s gross income for federal, state, and FICA tax purposes, providing savings on commuting costs. Additionally, the cost of group term life insurance coverage up to $50,000 is a pre-tax benefit.

Impact on Take-Home Pay and Taxable Income

Pre-tax deductions influence an employee’s take-home pay by lowering their taxable income. When taxable income is reduced, the amount of money subject to federal and, in most cases, state income tax decreases. This results in less tax being withheld from each paycheck, increasing the employee’s net pay compared to if the same amount were deducted after taxes.

Many pre-tax deductions, such as health insurance premiums, FSA contributions, HSA contributions, and commuter benefits, also reduce the wages subject to FICA taxes (Social Security and Medicare). Social Security tax is 6.2% on earnings up to an annual limit ($168,600 for 2024), and Medicare tax is 1.45% on all earnings. By reducing the FICA-taxable wage base, these deductions lead to lower FICA tax withholding. While retirement plan contributions like 401(k)s reduce income tax, they remain subject to FICA taxes.