What are pre-tax deductions?

Pre-tax deductions refer to the money deducted from an employee’s gross pay before taxes. The benefits of pre-tax deductions include reduced taxable income, meaning the employee will owe less income tax, and reduced employer-paid taxes such as FUTA, FICA, and SUI. The federal government annually reviews pre-tax deduction rules, limits, and regulations. Pre-tax deductions can be taken for medical care, life insurance, traditional 401(k) contributions, company-sponsored insurance, and commuter benefits. These benefits reduce the employee’s taxable income and may increase future Social Security credits and benefits. Pre-tax deductions are subject to limits, and post-tax deductions, such as union dues, do not reduce taxable income.

List of Pre-Tax Deductions

The pre-tax deductions allowed by the federal government are subject to change on an annual basis, along with regulations and limits. It is advisable to verify the most recent information regarding pre-tax deductions before making adjustments to payroll. Currently, the following items qualify as pre-tax deductions:

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

Do Pre-Tax Deductions Lower Taxable Income?

Yes, pre-tax deductions usually lower an employee’s taxable income because the money is taken out of their gross pay before taxes are withheld. Additionally, pre-tax deductions may reduce taxes for employers who pay FUTA, FICA, and SUI.

Pre-tax deductions change annually and are adjusted for inflation and cost of living by the federal government. This can impact the extent to which taxable income is decreased from one year to another.

On the other hand, post-tax deductions do not lower an employee’s taxable income because they are taken out of their paycheck after taxes are withheld. Post-tax deductions may include items such as union dues or other benefits that exceed the pre-tax deduction limits.

Examples of a Pre-Tax Deduction

Examples of pre-tax deductions include:

  • Retirement Funds: A traditional 401(k) can be a pre-tax deduction, and both the employee and employer can make contributions before the income is taxed.
  • Health Insurance: Health benefit plans like HSA or FSA are pre-tax deductions. Employers may also offer pre-tax deductions for employees who pay for their health plans.
  • Commuter Benefits: Commuter benefits are qualified fringe benefits that go into an employer-funded account, and this account is a pre-tax deduction. For instance, an employer may add $100 a month to a commuter account for a bus pass or train tickets.