Federal taxable wages are all earnings that, by law, are subject to federal taxes and must have taxes withheld. The Internal Revenue Service enforces the collection of Social Security tax, Medicare tax and federal income tax – federal taxes that employers withhold from employee's paychecks. However, many different types of income can make up an employee's taxable wages.
What Are Taxable Wages?
Federal taxable income includes wages, salaries, bonuses, awards and prizes the employer pays to the employee throughout the year. In addition, tips an employee reports to her employer, non-cash payments, some fringe benefits (such as a health benefits that is not a qualified cafeteria plan) and some business expense reimbursements (such as payments made to the employee under an accountable plan as defined by the IRS) are taxable wages.
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The IRS narrowly defines taxable income. Therefore, an employer should confirm with the agency to ensure proper calculation.
Consider also: Who Must File Income Taxes?
How to Calculate Taxable Wages
To determine the employee's federal taxable wages per pay period or for the year, the employer subtracts nontaxable deductions from his gross wages. Nontaxable deductions include medical and dental plans, flexible spending accounts and traditional 401(k) plans that meet the requirements of IRS section 125 code. These deductions are made on a pretax basis; the employer makes the deduction before withholding federal taxes, thus reducing the employee's taxable wages.
The only way an employer can offer its employees a choice between taxable and nontaxable benefits is via a section 125 plan. If the benefit is not pretax it is post-tax and is withheld from income after federal taxes are withheld.
Consider also: What Are Above-the-Line Deductions?
W-2 Placement for Taxable Wages
The employer reports the employee's federal taxable wages for the year in box 1 of her W-2 form. This is a critical document as it details an employee's earnings n the past year, as well as the amount of withholding. If an employee does not have nontaxable deductions then her entire compensation for the year should be included in box 1. If she has taxable deductions, box 1 should show her pay after these deductions have been subtracted from her annual gross income.
Most employers use payroll software that run the relevant calculations automatically and pre-fill the W-2.
Consider also: W-2 Forms: What It Is, Who Gets One & How It Works
Things to Consider
To arrive at the employee's federal income tax withholding per pay period or for the year, the employer uses the IRS Circular E withholding tax table relevant to the employee's taxable wages, filing status and other tax situation specifics (as shown on her W-4 form) and pay period. Circular E provides detailed guidance to employers about their federal tax withholding responsibilities and includes the obligations for filing employer tax.
In 2021, employers calculate Social Security tax at 6.2 percent of an employee's taxable wages, up to $142,800 annually; and Medicare tax at 1.45 percent of all her taxable wages, bringing the total to 7.65 percent. These rates are can only be changed through new tax law.