All year I pay taxes and look forward to receiving my W-2. When HR passed out the tax documents I was confused as to why there were different amounts. Can you explain why wages, tips and compensations are different than the social security wages? Why aren’t the boxes 3 and 5 the same as box 1? What do the other boxes mean?
You are not alone. There are many employees who are confused about the various boxes on a W-2. During orientation the company hands you a W-4 and asks you to complete without any explanation. This tells your employer how many exemptions, essentially taxes, are withheld from your paycheck. What you don’t realize is that your exemptions and retirement contributions will make a difference of what you notice at the end of the year.
One of the most common differences between box 1, box 3 and box 5 is the amount of employee contributions to deferred compensation plans such as traditional 401(k) and 457. In the year the contributions are made, deferred compensation contributions reduce the employee’s taxable income for income tax purposes, but not for social security or Medicare taxes.
That is the reason why the three mentioned boxes have different amounts.
If box two has a large number then you should revisit the HR department to adjust your exemptions. The reason is because you are basically giving Uncle Sam full disclosure to your money to “invest” how he pleases instead of you putting that “extra” money into a saving account while you reap the benefits of the interest and liquidity.
Now let’s explain the important boxes and what it means to you:
Box 1: Wages, tips, and other compensation. Box 1 reports your total taxable wages or salary for federal income tax purposes. This figure includes your wages, salary, tips you reported, bonuses, and other taxable compensation. Any taxable fringe benefits (such as group term life insurance) are also included in your Box 1 wages. Box 1 does not include any pre-tax benefits such as savings contributions to a 401(k) plan, 403(b) plan, health insurance, or other types of pre-tax benefits.
Box 2: Federal income tax withheld. Box 2 reports the total amount withheld from your paychecks for federal income taxes. This represents the amount of federal taxes you have paid-in throughout the year.
Box 3: Social Security wages. Box 3 reports the total amount of wages subject to the Social Security tax. For 2013, the Social Security tax is assessed on wages up to $113,700. This limit is called the Social Security wage base. If Box 3 shows an amount over the wage base, you will need to have your employer correct your W-2. Tips reported to your employer are not included in the Box 3 amount. Those tips are is reported in Box 7.
Box 5: Medicare wages and tips. Box 5 reports the amount of wages subject to the Medicare tax. There is no maximum wage base for Medicare taxes. The amount shown in Box 5 may be larger than the amount shown in Box 1. Medicare wages includes any deferred compensation, 401(k) contributions, or other fringe benefits that are excluded from the federal income tax. In other words, the amount in Box 5 typically represents your entire compensation from your job.
Box 12: Deferred Compensation and Other Compensation.
Once you file your taxes for the year, don’t spend it all at once. Make sure to maximize the dollar so that it works just as hard for you as you worked for it throughout the year.
If you have money management questions or seek advice toward your path to financial freedom send questions to contact@BahiyahShabazz.com and we will feature it on the blog.
©ShabazzMgmtGrp, LLC 2014. All Rights Reserved.