Salary deferrals allow your employees to contribute directly to their 401(k) account from each paycheck. When payroll is processed, 401(k) deferrals are deducted from employees’ paychecks and the net amount is paid to them. The entire paycheck amount is deducted from your books as a wage expense. The amount of the salary deferral deduction is recorded as a liability, which is tracked in an account often called 401(k) payables.
When the employee deferrals are remitted to the 401(k) trust account from the employer’s liability account, the liability is reduced to zero.
Then, when preparing your business tax return, you will report the full gross wage expense not reduced by any employee 401(k) deferrals. You paid your employees wages, but they just chose to defer a portion of those wages into the 401(k) plan instead of taking the cash. However, you still get a deduction for the full wage expense.
Pre-tax 401(k) deferrals are not subject to Federal income tax, but Roth contributions are. See these articles to learn more about the taxation of pre-tax and Roth contributions. Most states and municipalities exclude traditional 401(k) deferrals from taxation and withholding.
However, both pre-tax and Roth deferrals are subject to Social Security and Medicare taxes as well as State Disability Insurance, such as California SDI. Be sure to check with your payroll provider or tax advisor if you have questions about how your jurisdiction's tax rules apply to 401(k) withholdings and taxation. Pre-tax and Roth 401(k) contributions will be reported to employees in Box 12 of their W-2s.
Disclaimer: This content is for informational purposes only and is not intended to be construed as tax advice. You should consult a tax professional to determine what types of tax credits or deductions your company is eligible to claim.