Handling payroll and employee wage deductions is a complex task with no margin for error. Failure to deduct proper taxes can invite penalties from the IRS, and making an illegal wage deduction for a fringe benefit can result in a visit from a federal or state Department of Labor (DOL) auditor, or both.
Calculating an employee’s base pay is the easy job. With the plethora of possible deductions including federal and state taxes, child support, tax levies, creditor garnishments, uniform payments, overpayment compensation, and fringe benefits such as health and life insurance, calculating deductions is a much more difficult task. Payroll personnel need to understand what they can, can’t and must legally deduct from an employee’s wages before processing those checks.
Deductions (Not So) Simplified
Breaking deductions into simple terms, there are essentially two types:
- Voluntary: Deductions taken out upon employee request, such as payment for medical benefits
- Involuntary: Deductions taken out by order of someone other than the employee for things such as federal taxes or wage garnishments
But that’s where the simplicity ends. From uniform deductions to garnishments and everything between, states vary on what they allow employers to withhold from paychecks. To complicate matters further, some deductions are subject to federal, state and/or local taxes, and some aren’t. And, some deductions offer employees more control over the amount withheld. While calculating payroll deductions is complicated, it doesn’t have to be a burden when you understanding the compliance challenges.
A compliance plan should start with a review of six common payroll deductions, along with these compliance tips to ease your payroll calculation pain:
Payroll taxes withheld include federal income tax, FICA (disability, social security, Medicare), and state and local income taxes when applicable. Most workers expect federal and state taxes to be deducted from their paychecks, but taxation calculation is far from cut and dry.
Compliance Challenges: Some taxes are mandatory, some are a courtesy, and some the employee has control over the amount withheld. Adjoining states sometimes have agreements between each other on taxing out-of-state workers. Deduction amounts are determined by varying factors such as employee filing status and pay rate.
Compliance Tip: Know your state’s taxation laws! If you hire out-of-state employees, you’ll need to be up on neighboring states’ taxation laws as well. For example, Wisconsin has an agreement with Illinois stating that employees who residents in Illinois (but work in Wisconsin) need to complete form W-220 to avoid paying Wisconsin taxes. The Wisconsin employer may—but is not required to—withhold Illinois taxes.
Payroll garnishments withheld include child support, tax levies, creditor payments, employee loans or other debt payment required by court order to be withheld. Garnishments are governed by Title III of the Consumer Credit Protection Act (CCPA), which limits the amount employers can deduct from disposable pay for child support and creditor garnishments.
Compliance Challenges: Garnishment withholdings are riddled with challenges because of their complex calculations. Tax levy exemptions change year by year, and states vary widely on their creditor garnishment limits. Child support limits set by the CCPA are 50 percent of disposable earnings if the employee has a second family, but 60 percent if not, and state limits are sometimes lower. Disposable income is gross pay minus mandatory deductions, but calculating disposable income isn’t so simple because state laws vary on what is considered mandatory!
Compliance Tip: Know your state’s unique garnishment rules and fees as well as how to handle multiple garnishments. Also, watch out for voluntary wage assignments which aren’t the same as court-ordered garnishments and aren’t protected by CCPA limits.
3. Fringe Benefits
Payroll fringe benefits withheld include employee contributions to health insurance or group term life insurance. Deducting for voluntary fringe benefits is usually an easy task.
Compliance Challenge: Most fringe benefit deductions are voluntary and require employee authorization. But what about health insurance for a dependent child under a child or medical support order? These classifies as an involuntary fringe benefit deductions.
Compliance Tip: Keep accurate records, file employee authorizations and get payroll personnel proper training on how to process voluntary and involuntary health insurance deductions.
Payroll deductions for uniforms are determined by whether an employer or employee furnishes or pays for employee uniforms as well as their upkeep.
Compliance Challenge: Some states require a written notification from the employee to withhold uniform deductions, some states will allow a deduction if the deduction doesn’t put the employee below minimum wage, and some flat out don’t allow a deduction at all.
Compliance Tip: Contact your state and neighboring state labor office for a determination of uniform withholding policy.
Payroll overpayment deductions are taken when an employee was overpaid previously and needs to give the money back. These deductions include payroll errors as well as advances in wages.
Compliance Challenge: If the employer and employee don’t agree that the wages were overpaid or if the employee refuses to repay, legal options must be considered. Under the Fair Labor Standards Act (FLSA), if the employer loans or advances wages to an employee, it may deduct the principle from the employee’s wages, even if it cuts into minimum wage or overtime due.
Compliance Tip: Employers may need to have this contract in writing, and they need to know whether state or federal laws apply. Seek legal counsel and educate yourself. Research the wage and hour laws in your state, and make sure you understand what’s happened in previous lawsuits in situations similar to yours.
6. Meals and Lodging
Payroll meal and lodging deductions are taken if the employer provides them as part of the employee’s wages. Employers are permitted this deduction if it’s primarily for the employer’s benefit, the employee accepts it voluntarily, and if the lodging is the employee’s residency on a permanent basis.
Compliance Challenge: States vary on their rules for meals and lodging credits against minimum wage.
Compliance Tip: Know your state laws for lodging credits, and make sure the lodging is in compliance with the proper permits and zoning laws. Be aware of your state’s hour and cost restrictions for meal deductions, and make sure you meet all the terms before deducting wages.