A pre-tax deduction is a certain amount of money subtracted from an employee’s gross salary before withholding government taxes. The main reason for this deduction is to decrease the taxable income of an employee. Besides income tax reduction, it also plays a vital role in minimizing Federal Unemployment Tax (FUTA), Social Security, Medicare, and FICA tax.
What are the Types of Pre-Tax Deductions?
Often, the federal government makes some changes in the pre-tax deduction rules every year. As a result, there has been an incremental change in regulations of pre-tax deductions.
So, here’s an updated list of all the qualified types of pre-tax deductions:
Healthcare insurance: In many cases, health insurance is covered by pre-tax deductions for those who usually pay for it.
Savings account regarding health: There are several health benefit schemes like HSA and FSA which are often considered as pre-tax deductions.
Insurance coverage: Many employees spend money on various types of insurance policies. These insurances are covered by pre-tax deductions.
Dental and vision insurance: Insurance based on dental and vision care.
Short-term disabilities: Insurance premiums based on short-term disabilities.
Long-term disabilities: Just like short-term disabilities, insurance based on long-term disabilities can be part of pre-tax deductions.
Child care: For example, costs for daycare can be part of a pre-tax deduction.
Medical expenses: Insurances on medical expenses.
Life insurance: Life insurance is a crucial aspect of pre-tax deductions.
Commuter benefits: Employee’s account that covers commute and transportation costs.
Retirement funds: Retirement funds such as traditional 401(k).
Investments on Tax-deferred accounts: Accounts that contribute to tax deferrals.
Parking permits: Amount spent on parking fees.
What are the Benefits of Pre-Tax Deduction?
One of the biggest advantages of the pre-tax deduction is that it’s equally beneficial to both employers and employees. From the employee's perspective, pre-tax deduction covers most benefits and insurance before the gross salary is calculated for income tax purposes. As a result, the taxable income of an employee becomes reduced. In this way, employees get to save a large amount of money on taxes. With a private plan, they can pay fairly less money for health insurance and other coverages as well.
What is the Impact of Pre-Tax Deductions on Reducing Taxes?
Pre-tax deductions play one of the most important roles in reducing the taxable income of an employee. It’s because the deduction happens before withholding taxes, resulting in the reduction of the income tax as well.
It should be noted that the rate of pre-tax deduction changes from time to time. They are often adjusted according to the inflation rate and living costs in a certain region.
On the contrary, the post-tax deduction can’t alter or reduce the taxable income of an employee. On a post-tax deduction, the deduction will take place after the gross salary is being taxed, and will not affect the taxable income. But it can also have different sorts of benefits that pre-tax deduction doesn’t offer.