Pre-Tax vs Post-Tax: Are You Deducting Properly?

To be pre-tax or to be post-tax, that is the question. At least, that is the question when it comes to payroll deductions. While every payroll deduction can be classified as either pre- or post- tax, how does an employer correctly classify these deductions? While several are classified by IRS regulations, other deductions are a matter of choice. 

Pre-tax deductions

Pre-tax deductions allow employees to decrease their taxable earnings. This is typically done through a Section 125 plan that is regulated by the Internal Revenue Service (IRS). Section 125 plans are commonly referred to as Cafeteria Plans because employees can pick and choose what benefits they would like to include in their plan, similar to a cafeteria. Additional details about Section 125 plans can be found here. 

The most common pre-tax deductions under a Section 125 plan are:

• Premiums for employer sponsored health insurance plans 

• Health Flexible Spending Accounts (FSA)

• Health Savings Accounts (HSA)

• Certain 401(k) contributions

• Employee group term life insurance (up to $50,000 in coverage) premiums

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It is important to note that even though these benefits are deducted pre-tax, they may still be subject to taxes at a later date. For example, if an employee withdraws money from their 401(k) plan prior to retirement, the funds withdrawn may be taxable. 

Post-tax deductions

Post-tax deductions are made after taxes have been withheld. There are no immediate tax benefits to the employee or the employer. However, in the case of post-tax benefits, the employee will not be subject to taxes when they use the benefit in the future. Post-tax benefits are not regulated by the IRS so employers have more flexibility as to what they can offer their employees. 

Common post tax deductions are:

• Roth 401(k) contributions

• Disability insurance premiums

• Employee group term life insurance (if exceeds $50,000 in coverage) premiums

• Union dues

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While many employers rely on their payroll company to determine what is pre-tax and what is post-tax, it is important to review the deductions yourself. The burden falls on the employer in the case of a misclassification. 

Please note, this is not a comprehensive list of deductions and should not be considered tax advice. Consult with a CPA or tax specialist if you have questions regarding your deduction classifications.