How Employers Reduce Payroll Taxes
If you're looking for ways to reduce payroll taxes, you likely want to:
Lower your employer FICA bill without cutting pay or benefits.
Put more money in employees' paychecks at no cost to you.
Stay fully compliant, without taking on audit risk.
Most employers treat payroll taxes as fixed. You pay 7.65% of wages in FICA, your employees pay the same, and that's that.
In our experience, how you structure benefits changes how much of your payroll is taxable. Every dollar an employee spends on qualifying benefits through a pretax plan is a dollar neither of you pays FICA on. For most employers, the setup costs little or nothing, and the savings repeat every payroll.
This guide explains how the mechanics work, walks through worked examples, and covers what to watch for with newer programs.
BenefitSmart is a nonprofit that helps employers make sense of their benefits options. Book a free Benefits Review to see what pretax benefits could save your organization.
1. Understand where payroll tax savings come from
FICA is two taxes. Social Security is 6.2% on wages up to $184,500 in 2026. Medicare is 1.45% on all wages. Employers match both, for a combined 7.65% on most employees' pay.
Section 125 of the tax code lets employees pay for certain benefits before taxes through a cafeteria plan. Those dollars come out of taxable wages, so:
The employer saves 7.65% on every pretax dollar.
The employee saves 7.65% in FICA, plus federal and most state income tax.
The benefit itself doesn't change. Only the tax treatment does.
2. Start with a premium-only plan
The simplest version is a premium-only plan (POP). If employees already pay part of their health, dental, or vision premiums, a POP moves those payments from after-tax to pretax.
It takes a written plan document and a payroll change. Many payroll providers set one up for free or a small annual fee.
A worked example: 40 employees each contribute $150 a month toward premiums.
Annual contributions: 40 × $150 × 12 = $72,000
Employer FICA savings: $72,000 × 7.65% = $5,508 per year
Each employee saves about $138 a year in FICA alone, and more once income tax is included.
If your employees pay premiums after tax today, this is the fastest payroll tax savings available to you.
3. Add pretax accounts
The same cafeteria plan can hold other accounts. Every dollar employees put in lowers taxable wages the same way. The limits below are the IRS limits for 2026.
Account | What it pays for | 2026 annual limit |
|---|---|---|
Health FSA | Deductibles, copays, prescriptions | $3,400 |
Dependent care FSA | Daycare, after-school care, elder care | $7,500 per household |
HSA (through payroll) | Medical costs now or later; requires a high-deductible plan | $4,400 self / $8,750 family |
Commuter benefits | Transit and parking | $340 per month each |
A worked example: in the same 40-person group, 15 employees put $1,500 a year into a health FSA. That's $22,500 in pretax contributions, or another $1,721 in employer FICA savings.
One catch: HSA contributions only avoid FICA when made through payroll. Contributions employees make on their own still get an income tax deduction but not the FICA savings.
4. Know what to watch for with pretax wellness programs
Some vendors offer larger savings by pairing a pretax wellness program with a medical reimbursement plan. Employees pay a pretax amount, then get most of it reimbursed. Done correctly, these can be legitimate.
Done poorly, they create real tax risk. In 2023, the IRS Office of Chief Counsel (CCA 202323006) said that payments made without actual, substantiated medical expenses are taxable wages. Programs that send a flat monthly check regardless of care fall into that category.
Before signing with any vendor, ask:
How are reimbursements tied to real medical expenses? Ask to see the substantiation process.
How many plan documents are there, and who drafted them?
What happens in an audit? Who is responsible, and is there any guarantee?
What is the savings after fees? Get a per-employee number and check that no employee's take-home pay drops.
Reducing payroll taxes: start simple, then build
Most employers are leaving payroll tax savings on the table simply because nobody set up the plan. Start with a premium-only plan, add the accounts your employees will actually use, and evaluate newer programs carefully.
The savings are real, they repeat every payroll, and in most cases the benefits your employees receive get better, not worse.
Want to see the numbers for your organization? BenefitSmart's free Benefits Review looks at your headcount, current contributions, and payroll setup, and estimates what a pretax structure could save. Book your Benefits Review.
