4092 / How is a reduction in salary for a tax sheltered annuity treated for Social Security tax and income tax withholding purposes?

Excludable amounts paid into a tax sheltered annuity are not wages subject to income tax withholding, even if the amounts are derived from a salary reduction agreement.¹

The amount of salary reduction contributions to the plan is subject to Social Security taxes even though it is excludable from the employee’s gross income. Employer non-salary reduction contributions are not includable in wages for Social Security purposes.²

Under the final regulations, salary reduction agreement means a plan or arrangement under which payment will be made by an employer on behalf of an employee or his or her beneficiary under or to an annuity contract if the employee:

(1) elects to reduce his or her compensation under a cash or deferred election;