How to Calculate Income Tax After Pre-Tax Deductions

As an employee, unless you meet the qualifications for exempt status as stated on Form W-4, you must pay federal income tax. Most likely, you must also pay state income tax, and possibly local income tax. Pretax deductions are excluded from federal income tax. Your employer subtracts the pretax benefit from your wages before withholding federal income tax; this process reduces your taxable income. Whether pretax deductions are excluded from state and local income taxes depends on the ruling state and local agencies. To accurately figure income tax after pretax deductions, you must apply the right formula.

Calculate gross compensation for the pay period. Gross compensation is your entire pay before deductions. For example, you’re paid biweekly and earn $45,000 annually. Divide $45,000 by 26 annual biweekly pay periods to arrive at biweekly gross salary of $1,730.77.

Subtract pretax benefits from gross wages to arrive at taxable wages for federal income tax purposes. Pretax deductions include qualified 401(k) contributions; medical, vision, disability, vision, and life insurance; adoption assistance; health savings account; dependent care assistance; and transportation benefits such as parking and transit fees. For example, you pay $100 biweekly toward your pretax family health insurance plan. Subtract $100 from biweekly gross salary of $1,730.77 to arrive at $1,630.77, which is your taxable salary.

Figure federal income tax by retrieving your allowances and filing status respectively from lines 3 and 6 of your W-4 form. Go online and get a copy of IRS Circular E. Then, find the tax table in the Circular E that goes with your taxable wages, pay period and the allowances and filing status stated on the W-4. Suppose you claim married filing status and two allowances. Page 45 of the 2012 Circular E says taxable salary of $1,630.77 would be subject to federal income tax of $120 biweekly.

Apply the ruling agency’s guidelines if state and/or local income tax withholding apply. Each state and local revenue agency has its own requirements. The only way to handle pretax calculations properly for these types of withholding is to get the requirements from the respective agency. If pretax deductions are not included in taxable wages, subtract the benefit from gross wages before calculating state or local income tax according to the agency’s criteria. If pretax deductions are counted as taxable wages, subtract the benefit after deducting state or local income tax from gross earnings.

Tip

  • To arrive at your take-home pay, subtract any other deductions that you might have after taxes, such as garnishment or voluntary deductions that don’t qualify as pretax.
 

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