What Is A Pre Tax Deduction?

Employers can benefit from educating themselves on the different types of payroll deductions that can impact how they manage paycheck amounts in the workplace, and pre-tax deductions are one of the first they should learn about. Pre-tax deductions are payroll deductions that are withdrawn from a taxpayer’s total earnings before any taxes are withheld.


Key Takeaways:

  • A pre-tax deduction is a type of payroll deduction that is withheld from a taxpayer’s gross pay before taxes are withheld. 
  • Payroll deductions can be pre-tax, post-tax, voluntary, or mandatory, with some overlap between the four types.
  • There are many types of pre-tax deductions that can reduce a person’s taxable income, including but not limited to childcare expenses, commuter benefits, dental insurance, health savings account (HSA), healthcare insurance, life insurance, long-term disability, medical expenses, and flexible spending accounts (FSA), parking permits, retirement funds, short-term disability, supplemental insurance coverage, tax-deferred investments, and vision benefits. 
  • Pre-tax deductions benefit employees by lowering their total taxable income due to the withdrawal of adjustments from their gross income, so they owe less to the IRS.

What Is A Pre-Tax Deduction?

A pre-tax deduction or before-tax deduction is a type of payroll deduction that is withheld from a taxpayer’s gross pay before taxes are withheld. As compared to post-tax deductions that are subtracted from an employee’s wages after taxes have been withheld, pre-tax deductions will reduce a taxpayer’s overall taxable income, and therefore they will owe less money in income taxes to the IRS. Pre-tax deductions also reduce what is owed in state unemployment insurance (SUI) dues and federal unemployment tax (FUTA). Pre-tax deductions can also lower what a person owes in FICA tax such as Social Security and Medicare. 

Other Types of Payroll Deductions

The two main types of payroll deductions are voluntary and non-voluntary deductions. Voluntary or non-mandatory deductions are those chosen by the employee to be withheld from their net pay, such as costs related to health coverage, child support, or retirement savings plans. Non-voluntary or mandatory deductions are withdrawn without the taxpayer’s consent and include taxes, fines, and wage garnishments. 

Types of Pre-Tax Deductions

It is beneficial to check the IRS requirements for pre-tax deductions as they can be updated each year, including rules, limits, and regulations. There are many types of pre-tax deductions that taxpayers should be aware of when the tax season rolls around, including:

  • Child Care Expenses
  • Commuter Benefits
  • Dental Insurance
  • Health Savings Accounts (HSAs)
  • Healthcare Insurance
  • Life Insurance
  • Long-Term Disability
  • Medical Expenses and Flexible Spending Accounts (FSAs)
  • Parking Permits
  • Retirement Funds
  • Short-Term Disability
  • Supplemental Insurance Coverage
  • Tax-Deferred Investments
  • Vision Benefits

Benefits of Pre-Tax Deductions

In most cases, pre-tax deductions are beneficial for helping both employers and employees achieve tax savings. Employees can use pre-tax deductions to get coverage like a life insurance or health insurance plan before tax is withheld from their gross income. This usually saves the taxpayer money over time because their total taxable income is reduced. Pre-tax deductions often result in the employee paying less money in healthcare costs or health insurance premiums when they purchase health plans using pre-tax deductions instead of using after-tax dollars. 

Some pre-tax deductions are subject to FICA taxes such as Social Security and Medicare. In this example, the individual would pay Social Security and Medicare taxes based on a higher gross income. This can benefit the taxpayer in the long run by allowing them to increase their Social Security benefits to be credited in the future.

Cons of Pre-Tax Deductions

There is a limit to how much people can claim in pre-tax deductions because the savings can be so advantageous. Employees must adhere to the yearly limit of contributions their plan allows when claiming pre-tax deductions on their tax returns. 

Pre-Tax Deductions Vs. Post-Tax Deductions

The two main types of deductions are those subtracted before and after income is taxed. Here are some details about pre-tax and post-tax deductions and the difference between them:

Pre-Tax Deductions

Pre-tax deductions help lower an employee’s taxable income because they are withdrawn before withholding taxes. Pre-tax deductions usually reduce what an employee owes in income taxes and FICA taxes. Pre-tax deductions can also reduce what an employer owes in FUTA, SUI, and FICA taxes. Some of the benefits that are eligible for pre-tax deductions include:

  • Health Insurance
  • Life Insurance
  • Retirement Funds
  • Commuter Benefits

Post-Tax Deductions

Post-tax or after-tax deductions are withdrawn after the taxes have been withheld from an employee’s paycheck. The main types of post-tax deductions include:

  • Charitable Contributions
  • Disability Insurance
  • Small Business Retirement Plans (such as a Roth 401(k))
  • Wage Garnishments

Do Pre-Tax Deductions Reduce Taxable Income?

Yes, pre-tax deductions reduce taxable income for employees most of the time. This reduction is because there are pre-tax adjustments that are taken out of an employee’s gross income before income tax withholding. Employers may also experience reductions in taxable income from pre-tax deductions if they pay FUTA, SUI, and FICA. 

Pre-tax deductions work differently than post-tax deductions. Post-tax deductions will not reduce an employee’s taxable income because taxes are deducted from an employee’s income after the taxes are withdrawn.

Are Pre-Tax Deduction Amounts Constant?

The federal government adjusts pre-tax deduction amounts yearly to account for inflation and the cost of living. If an employer aims to be accurate when managing payroll taxes for their employees, it is necessary to research the latest rules, regulations, allowable maximums, and limits to ensure they are compliant with tax laws.  

If you are responsible for managing payroll tax deductions for a company and have questions about the process, it can be beneficial to get professional help. While there are resources like payroll software available to help you calculate payments, deductions, and employee contributions, this technology can be confusing to use without the background knowledge of a tax expert. Call us at Ideal Tax today if you need help understanding pre-tax deductions.

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