Definition of After-Tax Deductions
After-tax deductions are payroll deductions that, according to the IRS, are not eligible for tax exemption status.
What are after-tax deductions?
Have you ever been in your office, and an employee asks you to explain why some of the deductions on their paystub are pre-tax, and others are after-tax? When that question was posed, did you feel like a deer in the headlights? After all, who can know the mind of the IRS?
According to the IRS, after-tax deductions are not legitimate payroll tax exemptions. Some examples of after-tax deductions include:
- Various insurance coverages
- Hybrid retirement plans
- Gifts to charities
It’s not that some of these items can’t be taken as personal tax deductions when an employee files annual itemized tax returns. But they aren’t legitimate payroll tax deductions.
Why is it essential that you understand after-tax deductions?
Incorrectly assigning a deduction as an after-tax deduction rather than a pre-tax deduction will result in fines for you as the employer. Below is a table that explains how the IRS treats incorrect payroll tax payments.
IRS Payroll Tax Penalties
|# of days payment is late to the IRS||Penalty amount per instance|
|1 - 5 days late||2% of the incorrect tax amount|
|6 - 15 days late||5% of the total incorrect tax amount|
|16 days late or more||10% of the incorrect tax amount|
With that in mind, here’s a little more information about those after-tax deductions we briefly mentioned above:
- Certain types of optional insurance coverages, such as disability insurance or life insurance.
- Some retirement plans, such as the Roth 401(k). These plans act like traditional 401(k) plans but have Roth IRA filing status.
- Includes court-ordered garnishments.
- Charitable donations (these can’t be taken pre-tax from payroll because they are eligible deductions when individuals file annual tax returns).
Not only will you, as the employer, be impacted by these IRS fines, but your employees will also suffer. At a minimum, they will experience shaken confidence in you as an ethical employer. Your employees may also have to amend their previous tax filings and end up owing the IRS money.
These penalties for inaccurately applied deductions can add up over time.
What is the history of after-tax payroll deductions?
In 2019, Pennington County, SD, was hit with an $87,000+ fine as a result of improper payroll tax deduction practices. The IRS took a three-year look back at the county’s payroll practices, and penalties began to be levied as of 2016.
Because the practice included paychecks for all county employees, the fines quickly accumulated.
The US government implemented an income tax in 1861 as part of the Revenue Act of 1861. By 1913, employers were required to collect the tax via payroll processes. Due to significant complaints, the measure requiring the payroll tax process was repealed in 1917.
That reprieve only lasted until the 1930s and the inception of social security. At that point, employers had to create systems that ensured they were collecting specific payroll taxes.
Since then, the IRS code has become more complex and includes those income taxes that are pre-tax deductions and others that we’ve discussed that are after-tax deductions.
Other similar terms and resources to assist you
- Payroll taxes 101: What employers need to know
- What are payroll deductions?
- A reference guide to employer payroll taxes for small businesses
- Payroll tax penalties small businesses should know about
- FUTA – Federal Unemployment Tax Act
- SUTA – State Unemployment Tax Act
- SSI – Social Security Insurance
- FICA – Federal Insurance Contributions Act. This includes Medicare, Social Security, and Medicare surtax.
Summary of the definition of payroll tax deductions
Your company’s success is significantly dependent upon your reputation. Ensuring that you correctly assign your payroll tax deductions as pre-tax and after-tax will go a long way to ensuring that your payroll practices don’t derail your business’s forward momentum.
Similar glossary definitions you must know
Independent contractor: A self-employed individual. The contractor’s client (or the payer) has the right to control and direct only the result of the work — not what will be done or how it will be done.
Statutory employee: An independent contractor who is treated as an employee for Federal Insurance Contributions Act (FICA) purposes and as an independent contractor for federal income tax purposes.
Tax identification number (TIN): SSNs (individual social security numbers) are issued by the Social Security Administration (SSA); company TINs are issued by the IRS (Internal Revenue Service).
Workweek: Under the FLSA, a workweek is a fixed, regularly recurring period of 168 hours or 7 consecutive 24-hour periods. A workweek can start on any day of the week and at any time of the day.
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