Small business owners wear a lot of hats, including “explainer of tax forms.” When you hire your first, second or 50th employee, the employee completes a W-4, the form that lets you know how much to withhold in taxes from their paycheck. And that following January, you provide employees with W-2 forms so they can file their taxes.
The W-2 is the form you, as the employer, complete annually. The W-2 is your record of how much each employee was paid and how much tax was withheld. And yes, both forms are required by the IRS.
Withholding the correct taxes is crucial. Did you know that you’re accountable for explaining that process to your employees? That’s when you place the “explainer” hat on top of your head. It also means that you need to know the answers to their questions about their W-2s. As your trusted Payroll partner, we’re here to help you.
According to the IRS, employers engaged in trade or business who pay wages – including noncash payments of $600 or more for the year if any income, Social Security or Medicare tax was withheld – for services that were completed by an employee must file a W-2 for each employee (even a relative) for whom:
- Income, Social Security or Medicare tax was withheld.
- Income tax would have been withheld if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4, the Employee’s Withholding Allowance Certificate.
Fortunately, Payroll by Fingercheck makes it easier to calculate taxes, as does our handy payroll tax calculator. We can set you up in a few minutes. And here’s a quick guide to help you explain withholdings and deductions to your employees.
We’ve put together this guide to help you explain the nuances of the W-2 to your employees.
What do the boxes mean?
The W-2 is straightforward. It’s a series of boxes labeled by either a letter or a number. Before getting started, if you’re not using an automated payroll system like Fingercheck, you need to have the following information on hand:
- Employee’s Social Security number
- Business identification number
- Employee’s taxable income
- Employee’s taxes withheld
Then you’re ready to get started with the first part of the W-2 form.
The lettered boxes
On the W-2, Boxes A through F include:
- Box A: Employee’s Social Security number
No Social Security card? If your employee has applied for one but has not received it, write “Applied For” in Box A on the Social Security Administration copy. When your employee receives their card, you must issue a corrected W-2 form.
- Box B: Employer identification number (EIN)
This is your business identification number. It will be the same for all of your employees.
- Box C: Employer information (business name, address and ZIP code)
This is where your business is legally registered. It never hurts to double-check the address.
- Box D: Control number (optional)
The control number can be used for internal tracking. Leave this space blank if you don’t use control numbers.
- Box E: Employee’s first name, last name and middle initial
Input their data exactly as it appears on their Social Security card.
- Box F: Employee’s address and ZIP code
This should be their mailing address.
The numbered boxes
The next portion of the W-2 includes the numbered boxes. This is where wage-related data goes.
- Box 1: Wages, tips, other compensation
This is where you input all of the gross taxable wages you paid that employee in the past year. The amount includes wages, tips and other compensation (think bonuses). This is income that is subject to taxation.
- Box 2: Federal income tax withheld
This shows how much money you withheld from the employee’s wages. This is the box you show them if they have questions.
- Box 3: Social Security wages
This box indicates the employee’s total wages and tips that are subject to Social Security tax. This is now where you include the amount of pre-tax deductions.
- Box 4: Social Security tax withheld
This shows the amount of taxes withheld from the employee’s Social Security tips and wages.
- Box 5: Medicare wages and tips
Enter the amount the employee earned in Medicare wages and tips here.
- Box 6: Medicare tax withheld
Enter the amount withheld from wages and tips for Medicare.
- Box 7: Social Security tips
This is where you report the tips earned by the employee. Include that amount in Boxes 1 and 5, too.
- Box 8: Allocated tips
If you tipped your employee, then you report it here. Don’t include that amount in Boxes 1, 3, 5 or 7. Instead, your employee should use Form 4137 to calculate taxes on allocated tips.
- Box 9: Blank – leave it blank
- Box 10: Dependant care benefits
This box shows the total amount of dependent care benefits that you paid to an employee or incurred on their behalf. If the amount is over $5,000, include it in Box 1. Employees must also complete Part III of Form 2441, Child and Dependent Care Expenses, to figure the amount, if any, that they can exclude from their income.
- Box 11: Nonqualified plans
This is the box used to report distributions from a nonqualified plan or nongovernmental section 457(b) plan.
- Box 12: Specific compensation and benefit amounts
There are more than 25 codes related to Box 12. Box 12 is where you report specific compensation and benefit amounts. Such codes include life insurance coverage and the amount you contributed to retirement plans.
- Box 13: Check the appropriate box and fill in the amount
Third-Party Sick Pay
- Box 14: Other
This is where employers may report additional tax income. Examples include vehicle leases, union dues, employer-paid tuition assistance, and after-tax contributions to a retirement plan.
- Box 15: State EIN
Employers include their EIN with their two-letter code after it.
- Box 16: State wages, tips, etc.
Employers report how much of the employee’s wages are subject to state income tax. If your state does not have a state income tax, leave this box blank.
- Box 17: State income tax
Employers report the amount withheld. If your state does not have a state income tax, leave this box blank.
- Box 18: Local wages and tips
Employers report the total taxable wages if the employee’s wages are subject to local income tax. Leave this box blank if the locality does not have income tax.
- Box 19: Local income tax
Employers report the local income tax withheld. If there is none, leave this box blank.
- Box 20: Locality
List the city or locality in this box.
Types of wages
Now that we’ve explained the W-2 and what the boxes mean, let’s get clear about the types of wages.
Gross Wages is the total pay before taxes and deductions. For example, if you earn $40 an hour and work 40 hours a week, your gross wages are $1,600.
The paycheck stub indicates the current gross amount being paid in this check and the amount the employee has been paid year-to-date (YTD). In the case of hourly workers, the number of hours and rate of pay are shown. Gross earnings are the amount earned before any employee paycheck withholdings or deductions are taken out.
Taxable wages are the wages paid to employees that, by law, must have tax withheld.
Net wages are the pay after deductions have been taken.
Subject wages are all reportable for Federal and State Unemployment Taxes (FUTA and SUTA)
How do you figure out how much to withhold?
In the onboarding process, the first payroll document that your employees must complete is the IRS Form W-4 (Employee’s Withholding Certificate). The W-4 helps them determine how much federal tax withholding will be applied to their paychecks.
Key points for helping employees with Form W-4:
- Explain that federal income tax rates are progressive and vary by wage and filing status. As an employee’s taxable income increases, their tax rate also increases.
- An employee’s federal income tax liability can be reduced by deductions and credits.
- The IRS issued a redesigned W-4 in 2020. Make sure you download the redesigned form.
- The new form has different steps and calculations based on how an employee files taxes. The options include filing as single, married filing jointly, married filing separately or head of household.
- There are different steps for employees who have multiple jobs and/or spouses who work.
- And there are calculations for dependents when employees want to withhold more money due to earning additional income or to withhold less money due to exemption status.
After your new employee completes the W-4, you fill out the company information including your Employer Identification Number (EIN). Then you or your accountant enter the data into your payroll system. The IRS requires employers to keep a copy of every employee’s W-4 for four years. Onboarding by Fingercheck can help with this, too.
Don’t forget: Withholdings can be revised
Employees can change their withholdings by completing another W-4. You might want to encourage them to review their forms with their accountants. Some deductions also can be changed; for example, the employee may change health insurance plans during open enrollment.
What about taxes?
The tax section shows how much money was withheld for federal and state taxes. The paystub shows two amounts: the current paycheck and YTD.
- Federal Taxes
- The W-4 form helps employees determine how much federal tax withholding will be applied to their paychecks.
- Federal taxable income can be reduced by tax deductions and tax credits, which provide benefits to specific types of taxpayers.
- FICA (Federal Insurance Contributions Act)
- All U.S. taxpayers must contribute taxes to Social Security and Medicare. Some paychecks show FICA as one total amount; others break it down by program.
- Social Security
- All employees and employers pay a percentage of their gross wages to fund Social Security.
- When you retire, you start getting a monthly check from the federal government. The amount is based on how much money you made while you were working.
- Many people mistakenly think the “full retirement age” (the age you can start collecting the full payment amount from the Social Security taxes you’ve paid into the system) is 65. It’s not — if you were born in 1960 or later, the full retirement age is 67.
- The Social Security tax is 6.2% of gross income. Both employer and employee contribute that percentage.
- However, there is a maximum taxable wage every year. This year, your contributions end when you’ve earned more than $160,200.
- Medicare is a federal health insurance program for people 65 or older and certain younger people who have disabilities.
- The primary purpose of Medicare is to cover most hospital and medical (doctor’s appointments, etc.) expenses.
- The Medicare tax is 1.45% of gross income. Employers and employees both contribute that percentage to Medicare, and there is no income cap for the Medicare tax.
- State and Local Taxes
- Depending on where your employee works (not where the business is located), you also may be required to withhold state and local taxes.
- Some states have no state income tax but may collect municipality or transportation taxes, for example.
- Our tax partner CorpNet can help employers register to submit payroll taxes in each state where employees conduct business. Typically, registration is completed through the state’s department of revenue.
Do you need help with payroll or taxes?
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