What are deductions?

Deductions are the amount of money subtracted from an employee's gross income each pay period to determine their net pay. Deductions can be either involuntary, which means they’re mandated, or voluntary, which means the employee chooses them.

Below are some of the most common deductions you might see on an employee’s paycheck or pay stub.

Involuntary deductions

Involuntary deductions are mandatory, meaning they’re generally either required by law or court order.

Taxes

Taxes are mandatory deductions paid to the IRS. They’re calculated based on the employee's earnings and filing status. For W-2 employees, employers calculate and withhold payroll taxes, then file and pay them on each employee’s behalf. These include:

• Federal income tax withholding
• State income tax
• FICA taxes (Federal Insurance Contributions Act), which include Social Security tax and Medicare tax
• Local income taxes
• Payroll deductions. 

Wage garnishments

Wage garnishments are court-ordered deductions taken from an employee's paycheck to pay off a debt or obligation, such as child support, alimony, or unpaid taxes. Employers are legally required to withhold these amounts and send them to the correct agency.

Voluntary deductions

Voluntary deductions are deductions an employee chooses to take, but can also choose not to if they want to increase their take-home pay.

Retirement contributions

Employees may choose to contribute a portion of their earnings to a retirement plan, such as a 401(k) or IRA. These contributions can be pre-tax deductions, which reduce the employee's taxable income, or post-tax deductions, which do not reduce taxable income but may offer tax advantages upon withdrawal. Contributing to a retirement account helps employees save for their future and take advantage of potential employer matching programs.

Benefits costs

Deductions for benefits costs include health insurance premiums, dental and vision insurance, and life insurance. These deductions are often part of the broader employee benefits package. Employees can opt into these benefit plans, and the associated costs are deducted from their paychecks, often pre-tax, which can lower their taxable income and provide valuable coverage for themselves and their families.

Union dues

Employees who are members of a union may have union dues deducted from their paychecks. These dues fund the union's activities and support collective bargaining efforts.

Charitable contributions

Employees may choose to have charitable contributions deducted from their paychecks and sent directly to their chosen charities. These deductions can simplify charitable giving and may be tax-deductible.

HSA and FSA contributions

Health Savings Accounts (HSA) and Flexible Spending Accounts (FSA) are types of accounts that employees can contribute to for medical expenses. HSA contributions are typically pre-tax deductions and can be used to pay for qualified medical expenses. FSAs are also pre-tax and can be used to cover eligible healthcare expenses within the plan year. Both HSA and FSA contributions provide tax advantages and help employees manage out-of-pocket healthcare costs.

Net pay vs. gross pay

An employee’s gross pay, also called gross wages, refers to the total amount an employee earns before any deductions, including their base salary, overtime, bonuses, and other earnings. 

An employee’s net pay, on the other hand, is the actual amount they take home after all deductions, such as taxes and benefits, have been subtracted from their gross wages—the amount that’s deposited into their bank account on payday.

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How Form W-4 affects net pay

Form W-4, Employee’s Withholding Certificate, is the form employees use to indicate their tax situation to their employer so they know how much to withhold from their pay.

Things they can include on Form W-4 include how many dependents they have and other factors that help determine the amount of federal income tax that will be withheld from their paycheck. Properly filling out this form ensures that the correct amount of taxes is withheld throughout the year, which can impact the employee’s net pay and the tax return they file at the end of the year.

How to calculate net pay

Calculating net pay requires a few steps to make sure all necessary deductions are accounted for, resulting in the employee’s take-home pay. Here’s what to do.

1. Determining the employee’s gross pay. Start with the employee’s gross pay, which includes their hourly wage or annual salary, along with any overtime, bonuses, and other earnings.
• For salaried employees: Divide the annual salary by the number of pay periods (for example, if you run bi-weekly payroll, you’ll divide their salary by 26) to find the gross pay for each period.
• For hourly employees: Multiply the number of hours worked in the pay period by the hourly wage.
2. Subtract involuntary deductions, including federal, state, and local income taxes and FICA taxes. Calculate the amount to be withheld based on the employee’s earnings and filing status. Deduct any court-ordered wage garnishments.
3. Subtract voluntary deductions. These can include retirement contributions, benefits costs, HSA and FSA contributions, union dues, and any other voluntary deductions.
4. Calculate net pay. The remaining amount after all deductions is the employee’s net pay. This is the amount the employee will receive as their take-home pay.

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Frequently asked questions about net pay

Still have questions about net pay? Learn more in the FAQ below.

How can employers make sure their net pay calculations are accurate?

One way is by using payroll software or services that automatically calculate deductions and withholdings. Regularly auditing payroll records and keeping up-to-date with tax laws and regulations also helps maintain accuracy. Employers should also train payroll staff thoroughly to handle complex calculations and stay compliant with legal requirements.

Why might an employee’s net pay vary from paycheck to paycheck?

An employee’s net pay may vary due to changes in deductions, such as adjustments in tax withholdings, benefits, or retirement plan contributions. Other factors include overtime pay, bonuses, or fluctuating work hours.

What steps should an employer take if there is a payroll error?

If a payroll error is identified, employers should promptly investigate and correct the mistake. This includes verifying the error, recalculating the affected employee’s pay, and issuing any necessary adjustments. Employers should also communicate transparently with the impacted employee, explaining the error and the steps being taken to resolve it.

How do tax rates and tax brackets affect net pay?

Tax rates and tax brackets directly influence the amount of federal and state income tax withheld from an employee’s paycheck. Employers apply the correct tax rate based on the employee's income and filing status to calculate accurate withholdings, which affects the employee’s take-home pay.

How is net income different from net pay?

Net income usually refers to the total earnings of a business after all expenses, taxes, and costs have been deducted. Net pay, on the other hand, refers to the amount an employee takes home after all payroll deductions have been subtracted from their gross pay.

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