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What are Pre-Tax Deductions?

By Ken Black
Updated May 16, 2024
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Pre-tax deductions are deductions that can be used to discount the amount of taxable wages a person will owe taxes on. Without these deductions, an individual, in most cases, would owe income taxes on all their gross wages. However, with these deductions, that amount is lowered, becoming a tax benefit. A number of things can qualify as pre-tax deductions.

One of the major confusions in tax code terminology is the confusion between the terms pre-tax deduction and tax credit. A tax credit is a direct value based on the taxes owed. For example, a $100 US Dollar (USD) deduction means a taxpayer does not owe money on that $100 USD of income. If the person was in a 10-percent tax bracket, the value would be $10 USD. However, a $100 USD credit means there is $100 USD taken off the amount of taxes owed. Thus, a $100 USD tax credit, in this hypothetical situation, is 10 times more valuable than a $100 USD tax deduction.

Pre-tax deductions may also affect more than income tax. FICA, which includes taxes for Social Security and Medicare, is also affected. These pre-tax deductions can significantly lower the amount of money paid into this program as well.

The purpose of pre-tax deductions is to create an incentive for people to be responsible with their money and plan ahead for certain eventualities. These include health care expenses and retirement. Theoretically, even if the government takes in less money because of these deductions, it still is a net benefit to the government because individuals who plan ahead will not need as much government assistance in the future.

One of the most common pre-tax deductions is for healthcare expenses. This may include premium payments for health insurance or money that is placed into a health savings account. In some cases, benefits used from pre-tax deductions may be subject to income taxes at either the federal or the state level.

Pre-tax deductions are also used when the employee is investing in a retirement savings account, such as a 401(k). These often have the added benefit of having employer contributions as well. Together, this provides a great incentive for those to delay the benefits of the income in order to take advantage of it later on.

Another common pre-tax deduction is for flexible spending accounts. These accounts can be used for medical expenses, childcare expenses or even preschool expenses at a private school. However, those using such an account must be sure to spend the money by the end of the calendar year. Failure to spend all the money in the account will result in a forfeiture of that money.

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Discussion Comments
By anon327830 — On Mar 31, 2013

AFLAC Supplemental Plans are generally not exempt from taxes like "Cafeteria Plans" that fall under the IRS Section 125 code defining Cafeteria Plans. That was your answer.

You can stop reading now or you can try to follow this (rushed) opinion.

Before understanding the correct course of action, the one should understand the difference between the following terms:

Premiums: Amount of money deducted from employee's paycheck (before or after taxes).

Claims: Amount of cash paid to employee (or beneficiary).

Either the premiums should be taxed or the claims should be taxed.

Whether or not the premiums will be taxed is usually between the employer and the employee. AFLAC premiums can be pre-tax payroll deductions if the claims that are paid out are reported back to the employer. These claims are taxable if the premiums were not taxed. The opposite is also true.

Therefore, unless AFLAC is sending your company the amounts of claims paid during the calendar year to be added to the employee's gross income, then the deductions should probably be post-tax.

So why all the confusion? Most of the time, agents will tell you (off the record) that their Supplemental Indemnity Plans are "Cafeteria Plans". This inevitably makes their benefit plans more attractive to your employees. Agents will say this, knowing these plans are individually underwritten by AFLAC on a case-by-case basis. This is distinctly different from the "group plans," with clearly documented eligibility requirements and the corresponding pre-defined premium amounts.

Consequently, AFLAC can deny supplemental coverage for certain high risk people, which is fine; it's just not a Cafeteria Plan and therefore should be a part of the employee's taxable income (either the premiums or the claims). Remember, insurance companies cannot deny employee coverage for employees participating in Cafeteria Plans.

The whole "Contact your agent and they will help you figure it out" is usually a bad idea. I have friends who are insurance agents, AFLAC included, so this is not a personal knock against them, but they are sale agents not tax attorneys.

I hope this clears this up for you.

By anon318844 — On Feb 09, 2013

I'm somewhat unsure of exactly what to enter regarding Medical Expenses. My total medical bills exceeded 100K this past year. I have insurance and the vast majority of it was covered. My question is do I enter the original amount billed before insurance, or my part?

By anon314164 — On Jan 16, 2013

Can lodging be a pre tax payroll deduction?

By anon246429 — On Feb 09, 2012

If I have pre tax health insurance premiums, as well as pre tax health spending account on my pay stubs, do I use those totals as out of pocket health expenses on my tax return? --Sue

By anon244437 — On Feb 01, 2012

When did pre-tax deductions become available to the general public, and when did most employers begin using them? My mother is about to retire and they are advising her that all of her pension contributions were pre-tax. However, she started working there in 1975 and I also worked there then, and the pension was post-tax, there were no pre-tax deductions at that time. Thanks.

By anon242430 — On Jan 23, 2012

Prior to my current job, I have always had 401k taken from my paycheck. When i received my w-2's, the amount in Box 1 was higher than those in Box 3 and Box 5 by the amount of my contribution to the 401k (or were these the matching portions?)

All I know is that now I do not have a 401k, but I have pre-tax as well as post tax insurance premiums taken from my check. Now, the amounts in Boxes 1,3, and 5 are all the same. Is this correct?

By anon197414 — On Jul 17, 2011

Not sure how old those posts on here are but for those of you who have the Aflac questions, when you signed up for Aflac, we set-up a Cafeteria plan. You signed a M0138 form. This is what got Aflac available at your business. You should really talk to your agent about this. --David

By anon185882 — On Jun 13, 2011

RE: post 4 -- you can pre tax life insurance to 50,000 in your cafeteria plan, you can pre-tax life insurance in pensions like 401(k), 412i, and 457(b).

By anon161604 — On Mar 20, 2011

no actually, you can't. you will not get the tax savings without the cafeteria plans.

By anon153455 — On Feb 17, 2011

I am setting up pretax deduction for a cafeteria plan. Is the deduction before Fed, FICA, Med, FUTA, and PA state taxes?

By dpucalik — On Feb 01, 2011

I am setting up pretax deduction for AFLAC insurance. Is the deduction before Fed, FICA, Med, FUTA, and state taxes? There is not a Cafeteria or flexible spending plan. Can I still take this insurance premium as pre tax. The state is PA. Thanks, DP

By anon123570 — On Nov 02, 2010

will i be able to continue my pre-tax health deduction under the new health care reform act?

By anon60904 — On Jan 17, 2010

Can health insurance premiums that are deducted from pension payments be pre-tax? Or does the law specifically exclude this? About 25 percent of my pension payment is reduced by my insurance payments. Since it is not pre-tax, I must include it on schedule A as an itemized deduction and only for the amount that it exceeds 7.5 percent of my AGI.

By anon44754 — On Sep 10, 2009

Can life insurance policies ever be deducted through payroll as a pre tax?

By anon30171 — On Apr 14, 2009

Do all states accept the pre-tax deductions to be deducted from the gross wages to get to taxable wages?

By le8088 — On Mar 25, 2009

I am also setting up a pre-tax AFLAC deduction. We are a very small business. We have no flexible spending or cafeteria plans and frankly, I have no time to research these topics. Can we do the aflac deduction pre-tax without the flex or cafeteria? And is this deduction free from fed/fica/med/state taxes? As you can see, I am very unfamiliar with this. Thanks

By gpabs — On Mar 11, 2009

I am setting up payroll for pre-tax aflac insurance - I am not clear if the pre-tax is only on federal w/h or also on FICA (Social Security & Medicare). If it pre-tax on all these taxes, what about state income tax as well? I cannot find any answers on this - thanks GPABS

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