The Win-Win of Pre-Tax Deductions

Pre-tax deductions are great ways to increase net pay and reduce the tax bill to Uncle Sam at the end of the year. Surprising to some, there is a mutual incentive for businesses to offer pre-tax deductions to their employees. This mutual incentive is my favorite four letter word - FICA (also known as the Federal Insurance Contributions Act, or more commonly referenced as Social Security and Medicare).

As an employee’s taxable income is reduced, their FICA responsibility is reduced. In turn, businesses will also have reduced FICA responsibility on the employee’s lower taxable income. The 2020 FICA responsibility is 12.4% of taxable income for Social Security (6.2% from employee and 6.2% from employer) and 2.9% of taxable income for Medicare (1.45% from employee and 1.45% from employer).

When budgeting for FICA taxes each year, companies generally forecast the FICA percentage on their employees total gross compensation and do not account for pre-tax deductions that would reduce their FICA responsibility. This is for good reason as contributions toward pre-tax deductions are mostly unpredictable; however, it usually results in some extra money in your budget at the end of the year.

It’s important for companies to evaluate the pre-tax benefits they offer their employees and find where they fall short. Adding pre-tax benefits is a win-win situation for both the company and their employees. Here is a list of some common pre-tax benefits:

• Health Benefits

• HSA Plans

• Flexible Spending Accounts (Medical & Dependent Care)

• 401k Plan

• Pre-Tax Transit

• Pre-Tax Parking

• Supplemental Insurance Coverage

Below is a chart that outlines the potential FICA savings for an employee making $75,000 per year.

You can see in the above example, there is a potential to save $1,109 on one employee’s salary for that particular tax year. While the savings seem minimal there are a few things to be considered: (i) what is the average salary at your company? Don’t forget about high earners, this is where you will see a majority of your savings; (ii) what is the average pre-tax contribution? In this example I used a $4,500 401k contribution; however, the 2020 IRS maximum is $19,500 - do you have a lot of employees contributing the maximum?; and (iii) how many employees does your company have? $1,000 savings may appear to be small, but if you have 200 employees, that’s potentially $200,000 a year in FICA savings alone.

Sometimes adding benefits can be a daunting process, but consider what it can do for your employees and for your business as you continue to grow and seek out opportunities to find savings.