The Importance of Distinguishing the Taxable from the Non-Taxable
Payroll preparation is a complex process, and the matter of determining which of the payroll deductions are taxable can be quite confusing. However, one should have a clear understanding of payroll deductions in order to distinguish the taxable from the non-taxable.
Payroll deductions are dollar values taken from the gross salary of an employee; they can be either mandatory or voluntary. Those that are mandatory pertain to federal and statutory taxes, the values of which would depend on the amount of gross salary used as the basis for tax computations.
Voluntary deductions, on the other hand, pertain to the items listed in the Payroll Deductions Authorization form submitted by the employee. This particular aspect may seem easy at first but certain conditions could give rise to the complexity of determining which of the voluntary payroll deductions are taxable.
Some of these authorized reductions should be taken out of the employee’s gross salary first, before the tax rates are applied and before they are subtracted from the individual's wages. The IRS calls this the “pretax deduction" in which the resulting effect becomes a tax credit in favor of the employee.
In view of this, the explanations in this article have been organized according to the circumstances that render the payroll deductions taxable. That way, we can avoid creating a tax credit where it is not due. It should be best kept in mind that these types of salary reductions should be taken out of the employee’s wages after the tax calculation or post tax deductions.
However, before delving into the matter, there is also the matter of determining which of the payroll deductions are considered lawful.