Pre-tax deductions refer to qualified deductions which lower the taxable wages of your employees. You will deduct their contribution from the gross wages prior to determining their tax withholding. There are pre-tax deductions which also subtract the taxable wages for the income tax. Meanwhile, others reduce the taxable wages for Medicare and Social Security taxes.
How to Identify Pre-tax Deductions
After and pre-tax deductions can vary in the way that the latter reduces taxable wages right away upon making the deduction and the former doesn’t reduce taxable wages. The after-tax deduction will be taken out of the wages after the taxes have been computed. The pre-tax deductions wouldn’t always mean that the employee don’t have to pay taxes on the contributions. When the taxes apply in the near future, the tax liabilities will just be deferred until they become due, the best example being the pretax 401(k) contributions.
Types of Pre-tax Deductions
The pre-tax benefits usually come available in the form of Section 125 or cafeteria plan. The plan could include life and accident insurance, qualified health, as well as flexible spending accounts like medical and childcare reimbursement, and the adoption assistance programs.
Some other types of pre-tax benefits also include section 457, 403(b), and 401(k) plans, transportation programs which include parking and public transportation fees, and individual retirement accounts. To let your employees participate in the pre-tax plan, you should come up with a written plan which will satisfy the requirements of the IRS. Your state should have particular criteria that you also need to follow.
When you are a business owner, you have the option to offer your workers a basic pretax plan which can include retirement and health insurance options. You can also offer them a wider range of choices which include flexible spending accounts. You can get the assistance of a third party administrator to help you come up with the suitable plan for your business.
Rules on Taxation
All pre-tax deductions have their own tax implications. Majority of pre-tax benefits have been exempted from federal income tax as well as Medicare and Social Security taxes. But, when it come to the life insurance premiums on the coverage which goes beyond $50,000, retirement contributions and adoption assistance will be removed from the federal income tax, but not the Medicare and Social Security taxes. Such exceptions will apply even when you offer this benefit under the cafeteria plan.
Local and state income tax laws for the pretax plans can differ. In most cases, the federal treatment of the pretax plans will apply. When the local or state government considers pre-tax deductions being taxable, you can include the deductions in the wages of your employees when you calculate their taxes.
The Employee Benefits Security Administration of the United States Department of Labor states that employers who have group health plans should distribute summary plan description to all participants not later than 90 days following the start of the coverage of the participants. Employers also need to distribute this summary plan description to the participants every 5 years, and on request, distribute this document in a 30-day period.