What Are Pre-Tax Deductions?

Pre-tax deductions are basically a reduction to your income that occurs before the tax is levied. This type of deduction doesn’t show up on the quarter report given to your employer. It lowers your overall taxable income, meaning you pay less in federal and state taxes, which is the main benefit. It is important to realize that a tax credit is not the same thing as a pre-tax deduction. See below for the different examples of pre-tax deductions.

Employee Transportation

Employee transportation is one of the most common pre-tax deductions. There are a few different ways that you can go about this deduction though. For the method in which the employer pays the pre-tax deduction, the money is given to the employee to put towards transportation expenses for work. Another method for transportation pre-tax deductions is having a transit fund. This is used a lot in cities like Chicago where the public transportation is extremely popular. For this method, the employee allows a certain amount to be put into a transit fund and then this amount is not taxed.

401K Plans

Another extremely popular pre-tax deduction is the 401K plan. Basically, the set amount that is supposed to be put towards this plan is taken out of the employee's check before the taxes are calculated. Not only do you contribute to this plan before taxes, your employer on most accounts will also contribute to it. When you are filing your taxes at the end of the year, these pre-tax deductions are not shown on the W-2 form. When looking into retirement savings plans, it is important to know all of the fine print.

Health Care

Health care is often considered to be a pre-tax deduction. The amount for premiums is set aside before the taxes are calculated and then applied towards health care. This however may be subject to tax when it is being used. Whether it is taxed later depends on the plan or provider that the employee has.

Flexible Spending Accounts

Flexible spending accounts can be used for several things and are more common now than ever when it comes to pre-tax deductions. Basically you can use this account for a number of things from health care to child care and even school expenses. The one catch to this type of deduction is that the amount needs to be used up before the end of 1 year. If you do not spend the money in your flexible spending account by the end of that 1 year limit, you will have to forfeit it. So while this is a great option for those who know that the money will be spent, it can be a waste for those who are unsure or will not use it. It can be a risky account to sign up for and it is important to understand all of the limitations before deciding to participate in one.

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