Payroll Deductions: What They Are, How They Work, And What To Withhold

Every employee paycheck tells two stories: what someone earned, and what came out before they got paid. That second part, payroll deductions, is where a lot of small business owners run into trouble.

Get deductions wrong and you're looking at IRS penalties, tax liability, or confused employees asking why their check looks nothing like their offer letter. Get them right, and payroll becomes one less thing to worry about.

This guide covers everything you need to know: what payroll deductions are, which ones are mandatory, which are voluntary, how to calculate them, and how to stop doing it manually.

Payroll deductions, summed up

Payroll deductions are amounts withheld from an employee's gross pay before they get paid. Every paycheck has two types:

• Mandatory deductions are required by law: federal income tax, FICA taxes (Social Security and Medicare), state income tax where it applies, and wage garnishments when a court order is in place.
• Voluntary deductions are benefits employees elect, like health insurance or 401(k) contributions. These can be pre-tax or post-tax, which affects how much taxable income your employee has.

What's left after all deductions is the employee's net pay.

What are payroll deductions?

Payroll deductions are amounts withheld from an employee's gross pay before they receive their paycheck. They fall into two categories: mandatory deductions required by law, like federal income tax and FICA, and voluntary deductions employees choose, like health insurance or retirement contributions. Together, they determine an employee's net, or take-home, pay.

How do payroll deductions work?

Every pay period, deductions are calculated using a few sources: your employee's W-4 form, state withholding certificates, their benefit elections, and any active court orders. The amount you withhold changes based on all of these factors, plus where your business operates, since tax requirements vary by state.

The correct processing order is: pre-tax voluntary deductions first, which reduces taxable wages; then federal, state, and local tax withholding; then post-tax deductions and any garnishments. Garnishment amounts are determined from disposable earnings after legally required deductions are taken.

Most businesses use payroll software rather than doing this manually -- not because it's impossible, but because the margin for error is real, and the consequences of getting it wrong (late tax deposits, misfiled garnishments, misclassified deductions) add up fast.

Mandatory payroll deductions

Mandatory deductions are required by federal and state law. You have to withhold them from every paycheck when they apply. If you fail to withhold correctly, your business may be liable for the missing amounts plus penalties.

The most common mandatory payroll deductions are federal income tax, FICA taxes (Social Security and Medicare), state income tax where applicable, and wage garnishments when a valid order is in place.

Federal income tax

Federal income tax uses seven progressive tax brackets, ranging from 10% to 37%. "Progressive" means employees only pay higher rates on the portion of income that falls within each bracket, not on their full earnings.

How much you withhold depends on your employee's W-4, which shows their filing status (single, married filing jointly, or head of household) and any additional withholding they've requested. You calculate withholding using the wage bracket method or the percentage method, both found in IRS Publication 15-T. Payroll software handles this automatically.

FICA taxes

FICA taxes fund Social Security and Medicare. You withhold 6.2% for Social Security and 1.45% for Medicare from each employee's paycheck, and you match both amounts as the employer, making the total combined contribution 15.3%.

A few things to keep in mind:

• Social Security has an annual wage base limit that changes each year with inflation. Once an employee hits that threshold, you stop withholding Social Security for the rest of the year.
• Medicare has no wage base cap.
• For employees earning over $200,000 annually, you're required to withhold an additional 0.9% Medicare tax. You don't match this extra amount; it's employee-only.

State income tax

State income tax requirements vary significantly. Some states use a flat rate, others have progressive brackets, and some states don't tax wage income at all -- though the exact rules vary, so it's worth checking your state's requirements directly. Your withholding obligations are generally based on where your employees work, though residency, reciprocity agreements, and multi-state situations can affect this.

Some cities and counties add local income taxes on top of state taxes, which is common in places like New York City, Philadelphia, and parts of Ohio and Kentucky. Check with each state's department of revenue for current rates, forms, and payment schedules.

Wage garnishments

Wage garnishments are legally required deductions when a valid court order or government directive is in place. They can cover child support, unpaid taxes, defaulted student loans, or other judgments. Note that tax levies from the IRS don't always require a court order -- they're issued directly by the agency.

Garnishment amounts are calculated from disposable earnings after legally required deductions are already taken. The Consumer Credit Protection Act limits how much can be garnished per paycheck and protects employees from termination due to a single garnishment. When an employee has multiple active garnishments, priority depends on the type of order and applicable federal and state law. Wage garnishment services can help you manage the complexity.

Voluntary payroll deductions

Voluntary deductions are benefits and services employees choose to pay for through payroll. Unlike mandatory deductions, written employee authorization is generally required and considered best practice before you can withhold them, though exact documentation requirements vary by plan type and state.

The key distinction for voluntary deductions is whether they're pre-tax or post-tax. That choice affects how much taxable income your employee has and what you both owe in payroll taxes.

Health insurance premiums

Health insurance is often the largest voluntary deduction from an employee's paycheck. Premiums cover medical, dental, and vision coverage. When offered through a Section 125 cafeteria plan, they're deducted before taxes, which lowers your employee's taxable income and reduces your payroll tax obligations at the same time.

Employees can change their health insurance elections during annual open enrollment or after qualifying life events like marriage, a new child, or a change in employment status. Track these changes carefully and keep records of all enrollment forms and election updates.

Retirement contributions

Traditional 401(k) contributions are pre-tax: they reduce an employee's taxable income now and get taxed when withdrawn in retirement. Roth 401(k) contributions work the opposite way. They're made with after-tax dollars, but qualified withdrawals in retirement are completely tax-free.

The IRS sets annual contribution limits ($23,500 in 2025). Many employers offer matching contributions -- a common example is 50% of employee contributions up to 6% of salary, though match structures vary by plan.

FSA and HSA contributions

Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) let employees set aside pre-tax money for healthcare or dependent care expenses.

FSAs are generally "use it or lose it" -- funds must be spent within the plan year, though some plans allow a small carryover or a grace period. The healthcare FSA limit is $3,300 in 2025.

HSAs are only available to employees enrolled in a high-deductible health plan, but they offer a triple tax advantage: contributions go in pre-tax, grow tax-free, and come out tax-free for qualified medical expenses. Unlike FSAs, HSA balances roll over indefinitely and stay with the employee even if they change jobs.

Life and disability insurance

Employer-provided group term life insurance can be offered pre-tax for coverage up to $50,000. Coverage above that threshold generates what the IRS calls "imputed income" -- the taxable value of the extra coverage is added to the employee's wages. The IRS publishes tables for calculating this based on the employee's age and coverage amount.

Disability insurance protects an employee's income if they can't work due to illness or injury. Employees who pay disability premiums with post-tax dollars receive any benefits tax-free, which matters since disability benefits typically replace only a portion of regular income.

Union dues

Union members pay regular dues through payroll deductions to support union activities and representation. The amount is specified in the collective bargaining agreement, either a flat fee or a percentage of wages. Union dues are post-tax. For most W-2 employees, federal tax law no longer allows a deduction for union dues on the federal return -- some states may allow it, but this changed with the 2017 Tax Cuts and Jobs Act. As the employer, you're required to deduct and remit these amounts per your labor agreement.

Pre-tax vs. post-tax deductions

Whether a deduction comes out before or after taxes are calculated has a real dollar impact for both you and your employees.

What are pre-tax deductions?

Pre-tax deductions are subtracted from gross pay before taxes are calculated. This reduces the employee's taxable wages, which can lower what they owe in federal income tax, and in some cases state income tax and FICA taxes depending on the type of deduction. The exact tax effect varies by deduction and jurisdiction.

Here's a simplified illustration. An employee earns $4,000 per month. They have $500 in pre-tax deductions (health insurance plus a traditional 401(k) contribution). Taxes are calculated on $3,500, not $4,000. That difference saves them money on every paycheck, and it reduces what you owe on the employer side of FICA.

Common pre-tax deductions include health insurance premiums offered through a Section 125 plan, traditional 401(k) contributions, FSA and HSA contributions, and commuter benefits.

What are post-tax deductions?

Post-tax deductions are subtracted after taxes have been calculated on the full gross pay. They don't reduce taxable income now, but some offer tax advantages later.

Roth 401(k) contributions come out post-tax, but qualified withdrawals in retirement are completely tax-free. Wage garnishments are taken from disposable earnings after legally required deductions, which effectively makes them post-tax in practice.

Common post-tax deductions include Roth 401(k) contributions, wage garnishments, union dues, life insurance coverage above $50,000, and disability insurance when the employee wants future benefits to come out tax-free.

How to calculate payroll deductions

Here's the step-by-step process for calculating deductions. Even if you use payroll software, understanding these steps helps you catch errors and verify that payroll is running correctly.

1. Start with gross pay. Add up all earnings for the pay period: regular wages, overtime, bonuses, commissions, and any other compensation.

2. Subtract pre-tax deductions. Remove pre-tax voluntary deductions to get the employee's adjusted taxable wages. This includes health insurance premiums (through a Section 125 plan), traditional 401(k) contributions, FSA/HSA contributions, and commuter benefits.

3. Calculate federal income tax. Using the adjusted taxable wages and the employee's W-4 information, apply the appropriate withholding amount per IRS Publication 15-T. Actual withholding is determined by IRS tables and the employee's W-4 data, not a flat bracket rate.

4. Calculate FICA taxes. Multiply the adjusted taxable wages by 6.2% for Social Security (up to the annual wage base) and 1.45% for Medicare. Note that not every pre-tax deduction reduces FICA wages the same way -- for example, 401(k) contributions don't reduce FICA taxable wages, while Section 125 premiums do. Add the 0.9% additional Medicare tax for earnings over $200,000.

5. Calculate state and local income tax. Apply the correct rate for where your employee works. Multi-state situations can add complexity, so check with your state's department of revenue or a payroll professional if you have employees working across different states.

6. Subtract post-tax deductions. Apply remaining deductions in this order: garnishments first (amounts are calculated from disposable earnings and their priority depends on the order type and applicable law), then post-tax voluntary deductions like Roth 401(k) contributions, disability insurance, and union dues.

7. Verify. Confirm deductions are in the right order, no single deduction exceeds gross pay, and tax calculations reflect current rates.

The remaining amount is your employee's net pay.

Here's a simplified illustration for one employee earning $4,000 per month. Note that actual federal income tax withholding is based on IRS tables and W-4 elections, not a flat bracket rate -- the 12% figure below is used for illustration only:

• Gross pay: $4,000.00
• Less health insurance, pre-tax: -$250.00
• Less 401(k) contribution, pre-tax: -$200.00
• Adjusted taxable wages: $3,550.00
• Less federal income tax (illustrative only): -$426.00
• Less Social Security (6.2%): -$220.10
• Less Medicare (1.45%): -$51.47
• Less state income tax (illustrative only): -$177.50
• Net pay: $2,874.93

Doing this for every employee, every pay period, by hand is how payroll errors happen. A single misplaced decimal or outdated tax rate can mean an IRS notice, a short paycheck, or both.

Homebase payroll handles these calculations automatically -- federal, state, and local taxes, FICA, garnishments, and benefits deductions -- and updates for tax law changes across supported jurisdictions. Get started for free.

Common payroll deductions, broken down

Here's a quick summary of the most common payroll deductions, whether they're mandatory or voluntary, and how they're treated for tax purposes.

Mandatory withholdings: federal income tax, Social Security (6.2%), Medicare (1.45%), and state income tax where applicable. These are legally required withholdings, distinct from the pre-tax/post-tax benefit categories. They are withheld by the employer and, in the case of FICA, matched by the employer as well.

Wage garnishments: court-ordered or government-directed deductions calculated from disposable earnings after legally required deductions. Priority between multiple garnishments depends on the order type and applicable law.

Voluntary pre-tax deductions: health insurance premiums offered through a Section 125 plan, traditional 401(k) contributions, and FSA/HSA contributions.

Voluntary post-tax deductions: Roth 401(k) contributions, union dues, disability insurance (when the employee wants future benefits to be tax-free), and imputed income from life insurance coverage above $50,000.

Payroll deductions FAQs

What are payroll deductions?

Payroll deductions are amounts subtracted from an employee's gross pay before they receive their paycheck. These include mandatory withholdings like taxes and voluntary deductions like health insurance premiums or retirement contributions, which can be taken either before or after taxes are calculated.

What are the four mandatory paycheck deductions?

The most common mandatory payroll withholdings are federal income tax, FICA taxes (Social Security and Medicare), state income tax where applicable, and wage garnishments when a valid order is in place. Not every paycheck has all four -- state income tax doesn't apply in every state, and garnishments only apply when a court or government order requires them.

What are five types of payroll deductions?

The five most common types are federal income tax, FICA taxes (Social Security and Medicare), state income tax, health insurance premiums, and retirement contributions. The first three are mandatory withholdings; the last two are voluntary and generally require employee authorization.

Stop doing payroll deductions by hand.

Payroll deductions have a lot of moving parts: mandatory withholdings, voluntary elections, pre-tax and post-tax treatment, and garnishment rules that depend on order type and state law. When you calculate this manually, one outdated rate or missed step can cascade into IRS notices, unhappy employees, and hours of cleanup.

Homebase payroll automates deduction calculations -- taxes, benefits, garnishments -- and handles tax filings and remittances for supported jurisdictions. No more Sunday nights with a calculator. No more crossing your fingers that the math is right. See how Homebase payroll works.

Remember: This is not legal advice. If you have questions about your particular situation, please consult a lawyer, CPA, or other appropriate professional advisor or agency.

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