In the old days, employers had to withhold money from employees’ paychecks primarily for two purposes: income tax withholding and FICA. Income tax withholding applies for federal and state income taxes. FICA withholding is the employees’ share of Social Security and Medicare taxes. Over the years, employers have become the financial centerpiece of many employees’ lives, and this is reflected in withholding for a vast array of reasons. So that you can adapt your business practices, take note of some of the withholdings you may have to make in addition to income tax and FICA withholding.
Types of withholdings to consider:
Salary reduction contributions to retirement plans
While almost all big companies offer their employees the option to participate in a qualified retirement plan, such as a 401(k), that has employee contributions (salary withholding), it’s a different story at small businesses. According to ShareBuilder survey, only 26% offer a 401(k), believing it’s too costly and too much trouble to set up and manage. Interestingly, 401(k) plans can be run without any employer contributions, but most do entail some employer contributions and administrative costs. Even if small employers don’t have 401(k) plans, it doesn’t mean they are free from withholding. Expect to do withholding for employee contributions if:
- You are in a state that has a mandatory retirement plan for small private employers that lack their own retirement plan. At present, more than a dozen states have such plans in place, but more than half are considering them.
- You want to take advantage of federal tax incentives for setting up a plan. The credit, which was increased by the SECURE Act, could get another boost if Congress passes SECURE Act 2.0 (now titled the EARN Act).
Instead of a 401(k), small businesses can opt to use a SIMPLE-IRA. It is funded primarily through employees’ salary reduction contributions, but some employer contributions are required.
Other salary reduction amounts
You may give your employees the option of paying for some of their personal expenses on a pre-tax basis. As in the case of employee contributions to 401(k)s and SIMPLE-IRAs, this is done by salary reduction—the amount that would otherwise be wages are applied to specific pools of money for:
- Health FSAs
- Dependent care FSAs
- Cafeteria plans used to pay the employees’ share of health insurance premiums
State mandated withholding
Your state may require employees to make contributions to disability, unemployment, workers’ compensation, or family and medical leave funds; you must withhold accordingly. States with such mandatory withholding for certain purposes include Alaska, California, New Jersey, Pennsylvania, Rhode Island, and Washington. Beginning January 1, 2023, Oregon joins the list. Oregon law will require employees to pay into the system beginning January 1 and they can begin to collect benefits on September 3, 2023. This new Oregon law applies to employers with 25 or more employees. The contribution rate is 1% of compensation; with employers paying 40% and employees contributing 60%. Small employers are not required to make payments (if they choose to do this, they may obtain an assistance grant), but they must still collect and remit employees’ contributions. (Self-employed individuals can choose to participate.)
You may also have to do withholding if you receive a court order for garnishment to cover unpaid taxes or defaulted loans, alimony, or child support. Withholding is done according to the terms of the notice you receive from a state court.
Employers may act as a financial gatekeeper for employees by withholding money to be used to pay various personal things. Withholding for these items is after-tax, but helps employees manage their finances. This can include withholding for:
- S. savings bond purchases
- Pet insurance
- Union dues
- A contribution to the leave-based donation program set up by the company
One study earlier this year found widespread employee financial insecurity. This can lead to anxiety and depression, and problems on the job. By offering withholding for a wide array of expenditures that employees may want or need, you can help address financial insecurity.