Pre-tax deductions vs. Post-tax Deductions

Pre-tax deductions

Not all payroll deductions are created equal. Some people (although not many) may engage in a heated debate on the value of pre-tax deductions vs. post-tax deductions. Colleagues (even in our own organization) have asked “Why do we need post-tax deductions?” But, when understood, something magical happens and the rationale is clear.

What is a pre-tax deduction?

A pre-tax deduction allows an individual to set aside money from their pay before paying taxes. These funds are designated for a specific purpose (as permitted by the Internal Revenue Code). Pre-tax deductions occur before the individual’s tax obligations are determined. This saves the individual on Federal, State, Local (if applicable) and FICA obligations. The savings average 30-40% for an individual. Additionally, employers save 7.65% on payroll tax obligations.

What expenses can be paid with pre-tax dollars?

Pre-tax accounts provide individuals with instant savings of 30-40% on many known or predictable expenses. There are several deductions an individual can make on a pre-tax basis. These include:

  • Medical FSA / Limited FSA: Used to pay eligible medical expenses incurred during a designated plan period. Funds remaining in the FSA at the end of the plan year may roll on a limited basis (up to $500), if permitted by the plan. All other funds are subject to forfeiture rules.
  • Health Savings Account: Combined with a high deductible health plan to save on eligible medical expenses for today and tomorrow. Fund in an HSA automatically roll from year-to-year and are owned by the individual.
  • Dependent Care Account: Set aside up to $5,000 for eligible child care expenses.
  • Mass Transit Account:  Monthly election for mass transit and vanpool expenses.
  • Parking Account: Monthly election for workplace parking expenses.

What’s the catch with pre-tax deductions?

Pre-tax deductions are governed by the Internal Revenue Code. This means there are associated rules and regulations with each benefit. It is important to clearly understand what expenses are permitted, when expenses must be incurred and ultimately when they must be submitted for reimbursement. If you are not careful, there is often risk of lost funds or unreimburseable expenses.

Pre-tax deductions for Commuter Benefits

What is a post-tax deduction?

A post-tax deduction allows an individual to have amounts set aside from their pay after taxes for a designated purpose. If a pre-tax deduction is done for savings, a post-tax deduction is selected for convenience.

Why would I need a post-tax deduction?

You might be asking “Why would I need a post-tax deduction? Can’t I just pay out of pocket?” Let’s take a closer look at the most common scenarios.

Paying Mass Transit or Parking expenses

“10% of BRI commuter accounts have transit or parking expenses in excess of the IRS monthly maximum”

Approximately 10% of BRI commuter accounts have transit or parking expenses in excess of the IRS monthly maximum. When expenses exceed the IRS maximum, an additional post-tax deduction occurs to cover the cost. This deduction closes the gap between the IRS maximum and the amount of the transit expense. By making the post-tax deduction, the full amount of the transit expense is loaded to the benefits card (such as the Beniversal® Prepaid Mastercard®). The individual can then use their card to directly pay for their transit expense.

Without a post-tax deduction, a participant is at the mercy of the merchant. Here is a quick scenario to explain.

Sally and Sue each need to buy a train pass that costs $300. Sally buys her train pass online. Through the online portal she is able to enter multiple payment methods. It first takes the $270 from her benefits card. Then, she is prompted to provide an additional form of payment for the remaining $30. This is what is called a split transition. A merchant decides if they will support split transactions.

Sue on the other hand buys her pass at the train station vending machine. The train station will accept only one form of payment. Sue’s employer allowed her to make both pre-tax and post-tax deductions to cover her full transit expense. She uses her benefits card, the full $300 expense is available and she is on her way. If Sue’s employer had not been forward-thinking, Sue’s balance would have been $270 and the transaction would have been declined. Sue would be stuck with the bill and unable to use her benefits card.

Other reimbursement or savings programs

Employers may permit other post-tax payroll deductions. These may sometimes be combined with an offer from the employer to contribute towards the expense. Because these programs are done on a post-tax basis, the value is subject to taxes but they are not governed by the IRC. This provided added flexibility in how the program may work and/or what the account can be used for.

So, the next time you get in a heated debate over pre-tax deductions vs. post-tax deductions, you can provide a little clarity to the discussion. Alterntively, it you find yourself with high transit or parking expenses, you can take advantage of post-tax deductions for a frictionless experience.

Would you like to learn more about Commuter Benefits? Check out our ebook “How to Avoid Transit Compliance Failures“.