Do your employees understand what’s being deducted from their paychecks, and are they maximizing their take-home pay?
Many first-time workers are surprised to find out if they work 10 hours for $10 per hour their paycheck does not come to $100. That initial payroll “sticker shock” can be jarring. Before employees even cash their checks, deductions have been made to the government and other entities, diminishing earnings and causing workers to rethink their budgets.
Gross salary definition
Gross wages are the amount earned before taxes and deductions. This is the amount an employer offered either as an hourly wage or annual salary. The amount can be no less than the federal minimum wage, currently $7.25 for most workers, or a state or county’s minimum wage.
Gross pay is the amount agreed upon to accept the job, promotion, or transfer. Workers with multiple jobs may have multiple gross pay amounts, but the net amount they earn with every paycheck is much lower.
Net wages are the amount received once all necessary deductions have been made. Many employees refer to net pay as “take-home pay” — the amount you actually get to take home. Take-home pay is impacted by the amount of legally required deductions an employee has, as well as optional deductions they may choose.
Where does the money go?
In 1913, the federal government enacted an income tax, requiring workers to pay a portion of their wages to fund government spending. In the 1930s, a portion of those taxes was used for the new Social Security Act fund.
Originally, workers paid taxes the following year in quarterly installments; the Current Tax Payment Act in 1943 changed this. Taxes were then deducted and paid with every paycheck, shifting the burden of payments to employers. Ever since then, taxes have been withheld before employees have access to their earnings.
Deductions, deductions, deductions
Many different deductions impact an employee’s net — or take-home — pay. Some are required by law, others are optional.
Whether employees agree to it or not, taxes are withheld from every employee’s paycheck and FICA (Federal Insurance Contributions Act) deductions are also taken from each paycheck.
The IRS requires employers to make the deductions and remit the deducted amounts. These taxes are calculated when employees sign their W-4 withholding form, and they remain in place unless it’s updated. Only independent contractors are exempt from withholding taxes with each paycheck, but these workers are required to make the appropriate contributions to the correct agencies on their own.
Wage garnishments are court-ordered deductions that need to be withdrawn from an employee’s pay and sent to the company or person who has prevailed in a civil lawsuit. These deductions are legal in every state except Texas, North and South Carolina, and Pennsylvania.
All states (even those 4) allow mandatory wage garnishments for:
- Tax debt
- Child support
- Federal student loan repayment
- Court-ordered fines or restitution
The remaining 46 states allow garnishments for credit card or medical debt or other defaulted payments. Federal and state laws cap the amount of wages that can be garnished, typically 25% of earnings after taxes, or 30 times the current federal minimum wage — whichever is less.
Union dues may be withheld if the employee is covered under a collective bargaining agreement. While no employee is legally required to join a union, even if their employer or trade participates, deductions may still be required at a lower, administrative rate. These “agency fees” are withheld if workers get assistance from the negotiated contract in the form of wages and other benefits; they do not have to be a member of the union for this to happen.
In limited cases, an employer may deduct the cost of items that are “primarily for the benefit or convenience of the employer” under federal Wage and Hour law. This can include deductions for uniforms, uniform rental/cleaning, tools, etc. But if the deduction lowers the employee’s pay below federal or state minimum wage, it is not allowed to be made.
Employers under an Affordable Care Act (ACA) mandate to provide healthcare coverage for staff members may withhold part of the cost of coverage from an employee’s paycheck. Since the ACA individual mandate was repealed, employees are not required to accept healthcare coverage, although employers with 50 or more full-time employees are required to offer it to staff.
Flexible spending accounts are another deduction employees may opt to take from their pay before they cash their check. These can fund caregiver savings or medical accounts, providing staff members with pre-tax savings to cover specific expenses they incur during the year.
Retirement savings accounts and pension plans are popular deductions that impact net pay. Savings plan contributions may be deducted from pay on a pre-tax basis for employees to use when they hit retirement age. Some early withdrawals are also allowed, such as for purchasing a first home.
Other health and wellness deductions may be chosen, for long- and short-term disability, life, or supplemental insurance coverage. Some companies set up savings plan deductions for their staff members to set aside vacation or holiday funds throughout the year.
Voluntary wage garnishments, sometimes called wage assignments, may be requested by an employee to help them make support, credit, or other payments before they get their check. These need to be agreed upon in writing in advance and may be rescinded by the employee at any time.
Employees preparing for college tuition and expenses may opt for deductions made to a 529 plan. These “qualified tuition programs” allow anyone, including the employee, to set aside funds for their own or another’s future college tuition, fees, and other expenses. These plans allow for tax-free withdrawals as long as the funds are used for qualified purposes.
Many employers are providing 529 plan options to staff members planning for their children’s educational needs: some even offer matching contributions. 30 states offer some form of 529 Plan tax incentive to encourage employers to help staffers plan for college.
Making the most of net pay
For many employees, the sticker shock of gross versus net pay can be significant. Employers can help staff members get the most net pay possible under regulatory guidelines by suggesting they carefully assess the information they include on their W-4 payroll tax form. The new tax form for 2020 allows employees to more easily and accurately calculate deductions for the coming tax year that are in accordance with the new tax guidelines.
Too many employees sign tax forms when they first join an organization and forget about them for the duration of their career. They don’t take into account their life situation may have changed — with marriages, divorces, births, and children coming of age.
Businesses should encourage employees to review their W-4 annually to make sure their deductions are accurate and reflect their current situation. This can help workers make the most advantageous choices and may provide a larger portion of their wages as net, or take-home, pay.