Payroll Deduction: What It Means for Employers

What it means in practice

Every paycheck starts with gross pay and ends with net pay; payroll deductions are everything in between. They fall into four groups with different rules: deductions required by law (governed by federal tax law), deductions ordered by a court or agency, deductions the employee authorizes (shaped by benefit plan and tax rules), and deductions an employer makes to recover its own costs, which the Fair Labor Standards Act (FLSA) and state wage laws limit. All of them run through payroll.

Federal income tax withholding. IRS Publication 15 (2026) tells employers to withhold federal income tax from each wage payment according to the employee's Form W-4 and the correct table in Publication 15-T, which sets out the Wage Bracket and Percentage Methods. A new employee's W-4 takes effect with the first wage payment. If a new hire does not return one, the employer withholds as if the employee checked Single or Married filing separately and made no other entries. A replacement W-4 must be applied no later than the start of the first payroll period ending on or after the 30th day after it is received, and withholding for earlier pay periods is not adjusted. Bonuses and similar payments follow the supplemental wages rules.

Social Security and Medicare. The employee share of FICA must be collected "by deducting the amount of the tax from the wages as and when paid" (26 U.S.C. 3102(a)). For 2026, Publication 15 sets Social Security tax at 6.2% each for employer and employee on wages up to $184,500, and Medicare tax at 1.45% each with no wage limit. Employers must also withhold 0.9% Additional Medicare Tax starting in the pay period in which wages paid to an employee pass $200,000 for the calendar year, and continue through year end; there is no employer share. Publication 15 calls withheld income tax and the employee share of FICA "trust fund taxes," and if they are not withheld or not paid over, a trust fund recovery penalty equal to 100% of the unpaid tax may be assessed against responsible persons who acted willfully. Publication 15 also says that if an employer withholds too little Social Security and Medicare tax but reports and pays the proper amount, it may recover the shortfall from the employee.

Court and agency orders. A garnishment for a consumer debt, child support, a tax levy or a federal agency debt is a deduction the employer must make. The FLSA treats the amount paid to the third party as wages paid to the employee if the employer gets no profit or benefit, but any amount withheld above the Consumer Credit Protection Act limits does not count (29 CFR 531.39). Those limits are applied to disposable earnings, and DOL Fact Sheet #30 says deductions not required by law, such as health and life insurance, union dues, charitable gifts, voluntary retirement contributions and repayment of payroll advances, usually may not be subtracted when figuring them. A voluntary wage assignment the employee agrees to is not a garnishment (Fact Sheet #30).

Pre-tax and after-tax deductions. Whether a voluntary deduction lowers taxable wages depends on the plan behind it. Publication 15-B describes a cafeteria plan as a written plan that lets employees choose between cash or taxable benefits and certain qualified benefits on a pre-tax basis. Qualified benefits include accident and health benefits, adoption assistance, dependent care assistance, group-term life insurance and HSAs; meals, educational assistance, commuting benefits and several others cannot be offered through the plan. For 2026, a health FSA may not accept salary reduction contributions above $3,400 for plan years beginning that year, and up to $7,500 of dependent care assistance ($3,750 if married filing separately) can be excluded. HSA contributions made under a salary reduction arrangement in a section 125 cafeteria plan are not wages, but Publication 15 says employee HSA contributions made through an ordinary payroll deduction plan are wages subject to withholding and employment taxes. See flexible spending account and health savings account. Qualified transit and parking benefits can also be provided pre-tax through a compensation reduction agreement, up to $340 a month each in 2026 (Publication 15-B).

Retirement deferrals. Traditional 401(k) elective deferrals are generally exempt from federal income tax withholding but remain subject to Social Security, Medicare and FUTA tax (Publication 15, section 15). The IRS sets the 2026 deferral limit at $24,500, with an $8,000 catch-up for participants 50 or older, or $11,250 for those aged 60 to 63, and the plan may set a lower limit. Starting in 2026, plans with a Roth feature that offer catch-up contributions must take them on a Roth basis from participants whose prior-year wages with the plan sponsor exceeded $150,000. Designated Roth contributions are after-tax: the IRS says the employer includes them in gross income when the employee would otherwise have received the cash, and they are subject to all wage withholding. Deferrals become plan assets as soon as they can reasonably be segregated from the employer's general assets, and for a pension plan no later than the 15th business day of the following month; plans with fewer than 100 participants have a safe harbor for deposits made by the 7th business day after the pay date (29 CFR 2510.3-102).

Other voluntary deductions. Under 29 CFR 531.40, money paid to a third party at the employee's direction counts as wages paid if the employer derives no profit or benefit. The regulation lists savings bonds, union dues under a collective bargaining agreement, store accounts with independent merchants, premiums to independent insurers and voluntary charitable contributions as examples, and suggests keeping full records of each assignment and following state law on signing and delivery.

Deductions that benefit the employer. Wages must be paid "free and clear," and the FLSA is violated in any workweek in which the cost of tools the employer requires cuts into the minimum or overtime wages owed (29 CFR 531.35). Fact Sheet #16 applies the same rule to required uniforms and other items primarily for the employer's benefit, including tools, damage to the employer's property, customers who do not pay, and theft, "even if an economic loss suffered by the employer is due to the employee's negligence." The employer cannot avoid the limit by having the employee repay in cash. Its listed problems include charging a minimum wage cashier for a drawer shortage and charging tipped employees for walkouts. Board, lodging and other facilities are different: deductions for their reasonable cost may reduce cash pay below the minimum wage (29 CFR 531.36(a)). In an overtime week, a deduction for non-facility items may not exceed what could be deducted if the employee had worked only straight-time hours, and the regular rate is figured before deductions (29 CFR 531.37). Employee taxes count as wages paid, but no deduction may be taken for a tax the law places on the employer (29 CFR 531.38).

Exempt salaried employees. For an exempt employee, an improper deduction can affect the exemption itself. The salary may not be reduced for absences caused by the employer or by lack of work (29 CFR 541.602(a)). The exceptions in 541.602(b) allow deductions for full-day personal absences, full-day sickness absences under a bona fide plan, offsets for jury, witness or military pay, good-faith penalties for major safety rule violations, unpaid disciplinary suspensions of full days under a written policy, partial first and last weeks, and unpaid FMLA leave. DOL Fact Sheet #17G says an "actual practice" of improper deductions loses the exemption for the affected job classification and managers during that period, while isolated or inadvertent deductions that are reimbursed do not, and it describes a safe harbor for employers with a communicated policy and complaint mechanism. See exempt vs. non-exempt.

Example: one paycheck. A Remindax illustration with assumed numbers. An employee earns $2,000 biweekly, pays a $100 health premium through a cafeteria plan, and defers $100 to a traditional 401(k). The premium is excluded for both income tax and FICA (Publication 15-B, Table 2-1), but the 401(k) deferral is excluded only for income tax withholding. FICA wages are $1,900, so Social Security tax is $117.80 (6.2%) and Medicare tax is $27.55 (1.45%). Wages for income tax withholding are $1,800, and the withholding amount comes from Publication 15-T using the employee's W-4.

Example: a uniform deduction. Following the Fact Sheet #16 method, an employee paid $8.00 an hour works 40 hours and owes $45 for a required uniform. The most the employer may deduct that week is $30.00 ($0.75 above the $7.25 federal minimum x 40 hours). The remaining $15 may be taken in a later week only if pay again stays at or above the minimum. If the employee works 45 hours, the cap is still $30.00, the amount deductible for 40 straight-time hours (29 CFR 531.37). An employee paid exactly $7.25 cannot be charged at all.

Example: an exempt absence. An exempt employee paid $1,000 for a five-day week takes a day and a half off for personal reasons. Using the daily equivalent allowed by 29 CFR 541.602(c), the employer may deduct $200 for the one full day, but nothing for the half day (541.602(b)(1)).

Where states differ. Many states restrict deductions more than federal law; two examples from official sources. New York Labor Law 193 allows only deductions required by law or expressly authorized in writing by the employee for the employee's benefit, after written notice of the terms, from a listed set of categories such as insurance premiums, pension and health benefits, union dues, transit passes and similar payments; overpayment and advance recovery must follow state regulations, authorizations must be kept for the employment plus six years, and a revoked authorization must stop within four pay periods or eight weeks, whichever is sooner. The California Labor Commissioner says Labor Code 221 and 224 permit only deductions required by law, written authorizations for items such as insurance premiums, and collective bargaining health, welfare or pension contributions. It says losses from simple negligence, such as a dropped tray or a customer walkout, cannot be deducted, and only one loan installment may be taken from a final paycheck. Check your own state through the Department of Labor list of state labor offices.

Recordkeeping. FLSA records must show total additions to or deductions from wages each pay period, including purchase orders and wage assignments, and individual records must show the dates, amounts and nature of each item (29 CFR 516.2(a)(10)). Payroll records are kept at least three years, and the supporting records of additions and deductions at least two years (29 CFR 516.5 and 516.6; DOL Fact Sheet #21). State rules can be longer, as New York's six-year rule shows.

Questions employers ask. Can we deduct a cash register shortage? Not if it takes pay below minimum wage or into overtime under the FLSA (Fact Sheet #16), and states such as California restrict it further. Does an HSA payroll deduction lower taxable wages? Only when made through a section 125 cafeteria plan (Publication 15). Can we dock an exempt employee for a partial day? Generally not, except for unpaid FMLA leave and partial first or last weeks (29 CFR 541.602(b)). Confirm specifics with the IRS, the Department of Labor, your state labor department or a qualified professional.

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