What is the effect of pre-tax deductions on federal taxable wages?

• A. Pre-tax deductions reduce federal taxable wages; gross pay remains the same.
• B. Pre-tax deductions increase federal taxable wages.
• C. Pre-tax deductions do not affect federal taxable wages.
• D. Pre-tax deductions are taxed separately.

Answer: (A)

Pre-tax deductions reduce the amount of wages that are subject to federal income tax. They’re taken from gross wages before federal tax withholding is calculated, so the base used to compute federal income tax is smaller. The gross pay, which is the total earnings before any deductions, doesn’t change; what changes is the portion of that pay that is taxed for federal income tax. For example, if you earn $2,000 and contribute $200 to a pre-tax retirement plan, federal taxable wages are $1,800, and federal income tax withholding is based on that $1,800.