As an employer, you are required to withhold from an employee’s paycheck federal (and where applicable, state) income taxes, as well as the employee’s share of Social Security and Medicare (FICA) taxes. (Recently proposed regulations address withholding rules following changes by the Tax Cuts and Jobs Act and the revised Form W-4.) But this mandatory withholding is only the tip of the withholding iceberg. There are other reasons—some at the employee’s behest and others because of law—for which you must withhold additional amounts.
Mandatory withholding for…
As an employer you have no choice but to comply with mandatory withholding in certain situations. These include:
Additional Medicare tax. Once an employee’s annual compensation tops $200,000, you must withhold federal income taxes to cover the 0.9% additional Medicare tax (regardless of the employee’s filing status). This also applies to owners who work for their corporations and receive taxable compensation.
State programs. A growing number of states have mandatory withholding so that employees contribute to certain programs:
- State disability insurance (California, New Jersey, or New York Nonoccupational Disability Benefit Fund, Rhode Island Temporary Disability Benefit Fund, or Washington State Supplemental Workmen's Compensation Fund)
- Paid family and medical leave (New Jersey Family Leave Insurance (FLI) program and the California Paid Family Leave program)
- Unemployment benefits (Alaska, California, New Jersey, or Pennsylvania state unemployment fund)
Garnishment. If an employee fails to meet certain personal financial obligations (e.g., child support), a state court can issue an order of garnishment. Garnishment can also result from the IRS or state tax collection agency levies for unpaid taxes. A garnishment order instructs an employer to withhold a set amount and remit the withholding to the court or the person to be disbursed for the obligation. The Consumer Credit Protection Act puts a limit on how much can be withheld in response to a garnishment order.
Voluntary withholding for…
There is a growing trend for employers to act as sort of in loco parentis (in the place of parent) to help employees address their financial concerns. The following are some voluntary financial areas for which withholding can be made:
Retirement savings. Plans, such as 401(k)s and SIMPLE IRAs, allow employees to set aside a portion of their compensation to fund retirement savings. The money added to the plan is on a pre-tax basis (not subject to income tax but still subject to FICA). Salary reduction contributions can be entirely voluntary. Alternatively, an employer can use an automatic enrollment plan where a set percentage of employee comp is added to the plan unless the employee reduces the contribution or opts out entirely. There is a new federal tax credit of up to $500 per year for 3 years for employers that adopt or switch existing plans to automatic enrollment.
Medical expenses. Employees can agree to put pre-tax dollars into a flexible spending account for medical expenses. There’s an annual cap ($2,750 in 2020) on such employee contributions. Employees may also be able to contribute to a Health Savings Account (HSA). Unless the contributions are made through a cafeteria plan, they are includible in income as wages (not pre-tax) and are subject to federal income tax withholding and FICA; the employee deducts the contributions on his/her personal return.
Childcare. Employees can agree to put pre-tax dollars into a flexible spending account for childcare. The annual contribution can’t exceed $5,000.
Savings bonds. Voluntary wage withholding to buy U.S. savings bonds has been around for a long time. Of course, with the current low interest rates paid on these bonds, this savings option may not be as valuable as others (the Office of Personnel Management stopped its withholding program in 2009). For more information, see TreasuryDirect.
Emergency funds. Nearly half of U.S. households don’t have an emergency savings account. Setting aside funds to cover 3 months, 6 months, or more to cover basic living expenses or having a lump sum to pay for an unexpected emergency can help employees avoid anxiety and be better on the job. Again, this savings can be done through an app, such as Even’s Financial Wellness Platform, to help employees set aside some of their paycheck to meet their financial goals. This site charges an $8/month per employee fee that can be paid by the employee or covered by the employer.
Student loan repayment. There have been suggestions for payroll withholding to service student loan debt. For example, last year there was a proposal to allow withholding under two options, one of which would cancel any remaining debt after 20 years.
This list of the reasons for withholding from paychecks is not complete (e.g., there may be withholding for union dues), but should give you an idea of the breath of withholding options that employers should know about. Your in-house payroll or payroll provider should be able to handle withholding correctly.