What Are Federal Taxable Wages?

The employee files her federal tax return with the IRS.

Federal taxable wages are earnings subject to federal taxes. 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. Different types of income can make up an employee's taxable wages.

Identification

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. The IRS narrowly defines taxable income; an employer should confirm with the agency to ensure proper calculation.

Calculation

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.

W-2 Placement

The employer reports the employee's federal taxable wages for the year in box 1 of her W-2 form. If she 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.

Considerations

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 allowances (as shown on her W-4 form) and pay period. In 2011, it calculates Social Security tax at 4.2 percent of her taxable wages, up to $106,800 annually; and Medicare tax at 1.45 percent of all her taxable wages.

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