2.1 Salary and Wage Income
The key to reporting your pay is Form W-2, sent to you by your employer. It lists your taxable wages, which may include not only your regular pay, but also other taxable items, such as taxable fringe benefits. Table 2-1 explains how employee pay benefits and tax withholdings are reported on Form W-2.
Table 2.1 Understanding Your Form W-2 for 2012 Wages and Tips
| Amount in— | What You Should Know— |
| Box 1 | Taxable wages and tips. Your taxable wages, tips, and other forms of taxable compensation (2.1) are listed in Box 1. Taxable fringe benefits will also be included in Box 1 and may be shown in Box 14. |
| Box 2 | Federal tax withholdings. This is the amount of federal income tax withheld from your pay. Enter the amount on Line 62 of Form 1040, Line 36 of Form 1040A, or on Line 7 of Form 1040EZ. |
| Boxes 3, 4, and 7 | Social Security withholdings. Wages subject to Social Security withholding are shown in Box 3. Tips you reported to your employer are shown separately in Box 7. The total of Boxes 3 and 7 should not exceed $110,100, the maximum Social Security wage base for 2012. Social Security taxes withheld from wages and tips are shown in Box 4 and should not exceed the maximum 2012 tax of $4,624.20 ($110,100 × 4.2% rate). If you worked for more than one employer in 2012 and total Social Security tax withholdings exceeded $4,624.20, you claim the excess as a tax payment on your tax return; see 26.9. Elective salary deferrals to a 401(k), SIMPLE, salary-reduction SEP, or 403(b) plan, as well as employer payments of qualified adoption expenses, are included in Box 3 even though these amounts are not includible in Box 1 taxable wages. Amounts deferred under a nonqualified plan or a 457 plan are included in Box 3 in the year that the deferred amounts are no longer subject to a substantial risk of forfeiture. |
| Boxes 5–6 | Medicare tax withholdings. Wages, tips, elective salary deferrals, and other compensation subject to Social Security tax (Boxes 3 and 7) are also subject to a 1.45% Medicare tax, except that there is no wage base limit for Medicare tax. Thus, the Medicare wages shown in Box 5 are not limited to the $110,100 maximum for Boxes 3 and 7. In Box 6, total Medicare withholdings are reported. |
| Box 8 | Allocated tips. If you worked in a restaurant employing at least 10 people, your employer will report in Box 8 your share of 8% of gross receipts unless you reported tips at least equal to that share (26.7). The amount shown here is not included in Boxes 1, 3, 5, or 7, but you must add it to wages on Line 7 of Form 1040; you cannot file Form 1040A or 1040EZ. |
| Box 10 | Dependent care benefits. Reimbursements from your employer for dependent care expenses and the value of employer-provided care services under a qualifying plan (3.5) are included in Box 10. Amounts in excess of $5,000 are also included as taxable wages in Boxes 1, 3, and 5. Generally, amounts up to $5,000 are tax free, but you must determine the amount of the exclusion on Form 2441. The tax-free amount reduces expenses eligible for the dependent care credit; see Chapter 25. |
| Box 11 | Nonqualified plan distributions. Distributions shown in Box 11 are from a nonqualified deferred compensation plan, or a nongovernmental Section 457 plan (7.21). Do not report these distributions separately since they have already been included as taxable wages in Box 1. |
| Box 12 | Elective deferrals to retirement plans. Elective salary deferrals to a 401(k) plan or SIMPLE 401(k) (including any excess over the annual deferral limit; see 7.18) are shown in Box 12 with Code D. For example, if you made elective pre-tax salary deferrals of $4,500 to a 401(k) plan, your employer would enter D 4500.00 in Box 12. Designated Roth contributions (7.20) to a 401(k) plan are reported in Box 12 with Code AA. Code E is used for deferrals to a 403(b) tax-sheltered annuity plan (7.20), Code F for deferrals to a salary-reduction simplified employee pension (8.16), Code G for deferrals (including non-elective as well as elective) to a Section 457 plan (7.21), Code H for elective deferrals to a pension plan created before June 25, 1959, and funded only by employee contributions, and Code S for salary-reduction deferrals to a SIMPLE IRA (8.18). Cost of employer-sponsored health coverage. Your employer may show in Box 12, using Code DD, the total cost of your health plan coverage. Reporting is optional for employers who filed under 250 Form W-2s for 2011, and certain contributions, such as salary-reduction FSA contributions (3.16) and HSA contributions (3.2), are not reportable. Any amount reported here is not taxable; it is provided for informational purposes only. Travel allowance reimbursements. If you received a flat mileage allowance from your employer for business trips (20.33); or a per diem travel allowance to cover meals, lodging, and incidentals (20.32); and the allowance exceeded the IRS rate, the amount up to the IRS rate (the nontaxable portion) is shown in Box 12 using Code L. The excess is included as taxable wages in Box 1. Group-term life insurance over $50,000. The cost of taxable coverage over $50,000 is shown in Box 12 using Code C. It is also included in Box 1 wages, Box 3 Social Security wages, and Box 5 Medicare wages and tips. If you are a retiree or other former employee who received group-term coverage over $50,000, any uncollected Social Security tax is shown using Code M and uncollected Medicare tax using Code N. The uncollected amount must be reported on Line 60 of Form 1040 (Other taxes); write “UT” next to it. Nontaxable sick pay. If you contributed to a sick pay plan, an allocable portion of benefits received is tax free and is shown using Code J. |
| Box 12 | Uncollected Social Security and Medicare taxes on tips. If your employer could not withhold sufficient Social Security on tips, the uncollected amount is shown using Code A. For uncollected Medicare tax, Code B is used. This amount must be reported on Line 60 of Form 1040 (other taxes); write “UT” next to it. Excess golden parachute payments. If you received an “excess parachute payment as wages,” Code K identifies the 20% penalty tax on the excess payment that was withheld by the employer. This withheld amount is included in Box 2, but you also must add it as an additional tax on Line 60 (other taxes) of Form 1040; identify as “EPP”. Moving expense reimbursements. Tax-free employer reimbursements to you for deductible moving expenses (12.8) are shown with Code P. Employer contributions to health savings account (HSA) or Archer MSA. Total employer contributions to an HSA are shown with Code W. Total employer contributions to an MSA are shown with Code R. Contributions exceeding the excludable limit (Chapter 3) are included as taxable wages in Boxes 1, 3, and 5. Employer-financed adoption benefits. Total qualified adoption expenses paid or reimbursed by your employer (3.6) plus any pre-tax contributions you made to an adoption plan account under a cafeteria plan (3.13) are shown with Code T. Nonstatutory stock option exercised. If you exercised a nonstatutory stock option, Code V shows the taxable “spread” (excess of fair market value of stock over exercise price). The income should be included in Boxes 1, 3 (up to the $110,100 Social Security wage ceiling), and 5. Deferrals and income under Section 409A nonqualified deferred compensation plan. Current year deferrals plus all earnings under a 409A plan may be shown (its optional) with Code Y. Code Z shows amounts included as income in Box 1; this income is subject to a penalty plus interest on Form 1040 (2.7). |
| Box 13 | Statutory employee. If this box is checked you report your wage income and deductible job expenses on Schedule C (40.6). Your earnings are not subject to income tax withholding, but are subject to Social Security and Medicare taxes. Retirement plan. This box is checked if you were an active participant in an employer plan at some point during the year. As an active participant, you are subject to the phase-out rules for IRA deductions) (8.4). |
| Box 14 | Taxable fringe benefits and miscellaneous payments. Your employer may use Box 14 to report fringe benefits or deductions from your pay, such as state disability insurance taxes, union dues, educational assistance, health insurance premiums, or voluntary after-tax contributions to profit-sharing or pension plans. If your employer included in Box 1 the lease value of a car (3.7) provided to you, this value must also be shown in Box 14 or on a separate statement. |
| Boxes 17 and 19 | State and local taxes. If you itemize, deduct on Schedule A state and local tax withholdings shown in Boxes 17 and 19, unless you elect to deduct state and local general sales taxes (16.3). |
Your employer reports your taxable pay under a simple rule. Unless the item is specifically exempt from tax, you are taxed on practically everything you receive for your work whether paid in cash, property, or services. Benefits that the law specifically excludes from tax are discussed in Chapter 3. The most common tax-free benefits are employer-paid premiums for health and accident plans, medical expense reimbursements, and group-term life insurance coverage up to $50,000.
Your employer will include in Box 1 of your Form W-2 the total wages, tips, and other compensation, before payroll deductions, that were paid to you during the year. Box 1 may include, in addition to regular wages and tips, the following types of taxable compensation:
- Bonuses (including signing bonuses)
- Taxable fringe benefits (Chapter 3)
- Per diem or mileage allowances exceeding the IRS rate (20.32–20.33)
- Expense allowances or business expense reimbursements under a non-accountable plan (20.34)
- Awards or prizes not exempt under 3.11
- Cost of group-term life insurance over $50,000 (3.4)
- Cost of accident and health insurance premiums paid by an S corporation for 2%-or-more shareholder-employees
- Deferred income that is currently taxable under a Section 409A nonqualified deferred compensation plan (2.7)
Caution
Compensation reported in Box 1 must be reported as wages on Line 7 of Form 1040 or 1040A, or Line 1 of Form 1040EZ. Other types of income must also be reported as wages on your return although they are not included in Box 1 of Form W-2, such as non-excludable dependent care (3.5) or adoption (3.6) benefits, tips not reported to your employer or allocated tips (26.8), disability pension shown on Form 1099-R if you are under your employer’s minimum retirement age, or excess salary deferrals to an employer retirement plan (7.18).
Filing Instruction
Withholdings for retirement plans.
Amounts withheld from wages as your contribution to your pension or profit-sharing account are generally taxable as compensation unless they are tax-deferred elective deferrals under the limits allowed for Section 401(k) plans (7.18), simplified employee pension plans (8.16), SIMPLE IRAs (8.18), or tax-sheltered annuity plans (7.20). Elective deferrals are reported in Box 12 of Form W-2.
Wages withheld for compulsory forfeitable contributions to a nonqualified pension plan are not taxable if these conditions exist:
You should check with your employer to determine the status of your contributions.
Assigning your pay.
You may not avoid tax on income you earned by assigning the right to payment to another person. For example, you must report earnings that you donate to charity, even if they are paid directly by your employer to a charity. If you claim itemized deductions, you may claim a contribution deduction for the donation; see Chapter 14. Assignments of income-generating intellectual property are held taxable to the assignee. However, if the assignor retained power or control of the property, the assignor could be held liable for the tax according to the 8th Circuit.
The IRS allowed an exception for doctors working in a clinic. The doctors were not taxed on fees for treating patients with limited income (teaching cases) where they were required to assign the fees to a foundation.
Court Decision
Gifts from employers.
A payment may be called a gift but still be taxable income. Any payment made in recognition of past services or in anticipation of future services or benefits is taxable as wages even if the employer is not obligated to make the payment. However, there are exceptions for employee achievement awards (3.11).
To prove a gift is tax free, you must show that the employer acted with pure and unselfish motives of affection, admiration, or charity. This is difficult to do, given the employer-employee relationship. A gift of stock by majority stockholders to key employees has been held to be taxable.
Employee leave-sharing plan.
Some companies allow employees to contribute their unused leave into a “leave fund” for use by other employees who have suffered medical emergencies. If you use up your regular leave and benefit from additional leave that has been donated to the plan, the benefit is taxable and will be reported as wages on Form W-2.
“Golden parachute” payments.
Golden parachute arrangements are agreements to pay key employees additional compensation upon a change in company control. If you receive such a payment, part of it may be deemed to be an “excess payment” under a complex formula in the law. You must pay a 20% penalty tax on the “excess” amount in addition to regular income tax on the total. The 20% penalty should be identified on Form W-2 with Code K in Box 12; see Table 2-1.
If the golden parachute payment is made to a non-employee, the company will report it in Box 7 (non-employee compensation) of Form 1099-MISC. If you are self-employed, report the total compensation on Schedule C (40.6) and compute self-employment tax on Schedule SE (45.3). Any “excess parachute payment” should be separately labeled in Box 13 of Form 1099-MISC. Multiply the Box 13 amount by 20% and report it on Line 60 (other taxes) of Form 1040; label it “EPP.”