Setting Up Payroll Income and Deduction Types

If you’re new to the world of payroll, you’ve probably noticed that there’s quite a lot of jargon. There’s “gross pay,” “withholding,” “remittances,” and more. But it’s the terms “income and deduction types” that cause a great deal of confusion for those setting up payroll for the first time.

To fill you in, we’ll go over what income and deduction types mean and how to set up these fields in your payroll software.

Need more information? Check out: “Setting Up Payroll: The Ultimate Guide”

Regular Wages

Let’s start with basic payroll. In the most simple and straightforward scenarios, payroll looks at an employee’s gross annual or hourly pay rate, and then divides it by the frequency of payroll, before applying the necessary taxes. This scenario is an income type known as regular wages. Most payroll providers will automatically calculate regular wages for salaried and hourly employees or contractors using their rate of pay.

However, there are some cases where you will need to account for additional incomes and/or deductions beyond the regular wages. We’ll break down each below.

Income Types

Payroll incomes simply refers to any income you might receive in addition to your regular pay. Examples of common income types include:

• Bonuses: a payment that’s given to an employee over and above their regular wages.
• Commission: a payment that an employee receives when they complete a certain task, such as reaching a specific sales quota.
• Car Allowance: a payment that employers may provide if an employee uses their own vehicle to carry out their job.
• Overtime: additional income that an employee receives if they work more than the standard hours specified in the Code or Regulations—in most cases, this means eight hours in a day or 40 hours in a week.
• Expense Reimbursement: payments to an employee to reimburse them for out-of-pocket expenses they incur while carrying out their job, such as booking a flight or purchasing a meal.

These are just some of the most common income types, but there are many more. These income types will also not apply to every employee, therefore you will have to set up these income types yourself in your payroll system.

When setting up income types in a payroll system, employers can generally choose from a list of predefined earning types (although some platforms do support custom income types). After adding the appropriate income types, the correct tax settings for each income type will be activated. Employers will also have to set up the additional earnings to be paid out per paycheque or once on the next paycheque.

Note that if you are setting up an independent contractor instead of an employee, you may need some additional information, such as the CRA Number (if the contractor is associated with a business).

Deduction Types

In addition to income types, setting up payroll also involves adding deduction types.

Whenever you run payroll, a certain portion is always deducted from an employee’s income for payroll taxes. Therefore, deductions simply refer to the amount that an employee pays to cover employment expenses. Some of the most common deduction types include:

• Health Insurance: If an employee is participating in a health insurance program, medical, dental and/or vision health premiums will be held back from an employee’s paycheque.
• Life Insurance: if employees receive life insurance coverage, the premiums associated with the coverage will be deducted from an employee’s pay (unless the employer is paying the premiums).
• Short-Term and Long-Term Disability: if an employer provides disability coverage, insurance premiums will be held back from an employee’s paycheque.
• Registered Retirement Savings Plan (RRSP): if employees are saving for retirement, an RRSP deduction type would be used to manage employee contributions deducted directly from their payroll.
• Union Dues: if employees are unionized, each employee’s membership fees would be held back from their payroll.

While these are some of the most common deduction types, but there are some less common ones that may also apply to your business.
Much like setting up income types, setting up your deduction types will generally involve choosing from a list of predefined deductions. Again, some providers will also support custom deduction types. After adding the appropriate deduction types, the correct tax settings for each deduction type will be activated.

It is also worth noting that since most payroll providers automatically calculate source deductions like Canada Pension Plan (CPP) and Employment Insurance (EI), you do not need to set these up as a type of deduction.