The Form W-2, Wage and Tax Statement, is a form millions of Americans receive annually. The form is required to be prepared by every employer engaged in a trade or business who pays remuneration for services performed by an employee.
The form is prepared with five copies to be distributed as follows:
- Social Security Administration
- Employee’s federal tax return
- Employee’s records
- State, City, or Local Tax Department
- Employee’s State, City, or Local Income Tax Return
The form contains 20 numbered boxes and 6 information boxes labeled a-f. By examining the completed form you can identify a lot of information about an individual and their employer.
The information boxes a-f probably get glanced over quickly and the focus moves to the numbers reported in boxes 1-20. You should always verify the “employee social security number” in box “a” to be sure it is your correct social security number. You should also verify the “employee’s first name, initial, and last name” in box “e” to be sure this is consistent with your name as known by the Social Security Administration. Boxes “a” and “e” are key to making sure the information reported is attributed to the correct individual – you.
Moving onto the 20 numbered boxes, let’s start off with boxes 1-6. These boxes can be evaluated in pairs and contain the meat of the earnings and withholding information on this form. Often times boxes 1, 3, and 5 are talked about together, but I want to cover boxes 1 and 2, then 3 and 4, and finally 5 and 6.
Boxes 1 and 2: Wages, tips, and other compensation AND Federal income tax withheld are good to look at together. These will be key numbers used in the preparation of your individual tax return. Take note of the federal income tax withheld (box 2) as a percentage of wages, tips, and other compensation (box 1). Even though the federal income tax rates vary from zero to 39.6 percent, most often the federal withholding is 8 to 20 percent of the wages. Evaluate this relationship to understand what might be the result on your income tax return; refund or tax due.
Boxes 3 and 4: Social security wages AND Social security tax withheld are also a logical pair to view together. The withholding rate for social security tax is 6.2 percent. Verify this relationship.
Boxes 5 and 6: Medicare wages and tips AND Medicare tax withheld also have an easy relationship to understand. The withholding rate for Medicare tax is 1.45 percent. Verify this relationship.
Okay, now let’s look at boxes 1, 3, and 5. In many cases the numbers in these boxes may be the same. But, there are numerous very common situations when these numbers will all be different. Starting with box 5; it could be the highest of the three as most all compensation is subject to medicare tax and there is no base amount or upper limit. Whether you receive wages of $100 or millions, the tax withheld will be 1.45 percent of the amount in box 5. Box 3 could be less than box 5 and possibly more than box 1. There is an annual cap on the amount of wages subject to social security tax. For 2013 that amount was $113,700 and for 2014 the amount will be $117,000. Box 1 could be the lesser of the three boxes. If you have wages deferred into a retirement plan those wages are not included in box 1, but they will be included in both boxes 3 and 5. Therefore, looking at boxes 1, 3, and 5 and seeing the relationship will tell you what a person may be doing to plan for retirement as well as using other wage deferral means. These various deferral items will likely show up in box 12 and be specifically identified by one of 26 codes that are attached to these box 12 items.
Speaking of the 26 items that could possibly be reported in box 12, let’s review a few of the more common items. You can learn a lot about a person’s habits and tendencies from the items in box 12.
- Code C – taxable cost of group-term life insurance: if the employee receives group-term life insurance coverage over $50,000 the taxable cost of the excess needs to be reported here. Seeing amounts in this box indicates that the employer offers group-term life insurance and the coverage provided this employee exceeded $50,000. This amount will also be included in the amounts that appear in boxes 1, 3, and 5.
- Codes D through H, S, Y, AA, BB, and EE are used to report elective deferrals and designated Roth contributions made to various types of employer sponsored retirement plans. With the exception of Roth contributions, these amounts will generally be included in boxes 3 and 5, but not in box 1. These items will indicate how the employee is saving and funding retirement assets out of current compensation in a tax deferred manner:Code W – employer contributions to a health savings account (HSA).
- D: elective deferrals under section 401(k)
- E: elective deferrals under a section 403(b) salary reduction agreement
- F: elective deferrals under a section 408(K)(6) salary reduction SEP
- G: elective deferrals and employer contributions to any governmental or nongovernmental section 457(b) deferred compensation plan
- H: elective deferrals under section 501(c)(18)(D) tax-exempt organization plan
- S: Employee salary reduction contributions under a section 408(p) SIMPLE plan
- Y: deferrals under a section 409A nonqualified deferred compensation plan
- AA: designated Roth contributions under a section 401(k) plan
- BB: designated Roth contributions under a section 403(b) plan
- EE: designated Roth contributions under a governmental section 457(b) plan
- Code DD – cost of employer-sponsored health coverage. This quantifies a very significant benefit provided by the employer. The reporting of such is only required for employers who issue 250 or more W-2s. The amount reported using DD code is not taxable, it is strictly informational only and not included in the amounts that appear in boxes 1, 3, and 5.
Box 10 is used to report dependent care benefits. Therefore, if an amount appears in box 10 the employee must have children of young ages. The excess of amounts in this box over $5,000 will be included in boxes 1, 3, and 5.
Box 14 is used to report a variety of “other” items such as annual lease value of an employer provided auto based on the personal use reported by the employee (included in boxes 1, 3, and 5), union dues, health insurance premiums deducted, uniform payments, and employer contributions to a pension plan for the employee.
In box 13 there are three boxes that, when “x’d” will indicate the employee is a “statutory employee” or a “retirement plan” participant or that “third-party sick pay” is being reported.
The employer will use box 15 to indicate the state associated with the wages and withholding information that appears in boxes 16-20.
In summary, we can know from a form W-2 about employer provided tax deferred benefits, whether the employee has kids in day care, how the employee is planning for retirement or what opportunities the employee has for doing such, if the employee has access to medical insurance through an employer plan, what state the employee is subject to tax in, if the employee belongs to a union, and at what rate the employee is having federal and state income taxes withheld on the taxable compensation from his/her employer.
The W-2 provides a wealth of information and can be a source to prompt a number of questions when interviewing a client for tax return preparation or general financial planning.