Taxable Wages vs Gross Salary or Wages

The Taxable Wages vs. Wages (or Salary)

Gross taxable wages is a major component of paycheck calculations

Your gross taxable wages drives much of what is going on as far as your paycheck is concerned.  For example, it’s the starting point for determining your Social Security and Medicare taxes as well as your federal and state tax withholdings.  But determining your gross taxable wages should be easy, right?  After all, if your salary is $50,000 a year and you’re paid once a month then it would be natural to think that your gross monthly taxable wages would be calculated as follows:[1]

However, what if I told you that your gross monthly taxable wages were actually $4,181.67, or $15 higher than $4,166.67?  What’s going on?  Where is the extra $15 coming from? The answer is that $4,166.67 is equal to your gross monthly wages, not your gross monthly taxable wages.[2]

Non-cash fringe benefits

What’s the difference between your gross monthly wages ($4,166.67) and your gross monthly taxablewages ($4,181.67)?  The answer is that sometimes a company will provide you with non-cash fringe benefits that are taxable.  A non-cash fringe benefit (or simply a “fringe benefit”) is something of monetary value that your employer provides to you in addition to the pay you receive.  If a non-cash fringe benefit is taxable the law requires your employer to add an amount to your gross income equal to the value of benefits you receive.

For our example we’ll assume that your employer has a policy of providing each employee with life insurance coverage equal to three times salary, which in your case comes to $150,000 (your $50,000 base salary x 3).  This exceeds the $50,000 tax-free amount allowed under current law by $100,000, and that extra life insurance coverage would cost $15 a month if you bought it on your own.[3]  And from the government’s perspective that’s exactly the point – it’s as if your employer paid you an extra $15 a month which you then used to purchase life insurance.  As a result, the law requires your employer to add an extra $15 to your gross income each month (or $180 a year) so that it will be included in the taxable wages you’ll report on your income tax return.

Note that in some cases non-cash fringe benefits are also non-taxable.[4]  For example, if a company stocks drink machines with free sodas that any employee can get just by pressing a button then that likely qualifies as a non-cash fringe benefit that’s also non-taxable.  In other words, you’re able to get sodas without for paying for them and you don’t have to count the value of the sodas you consume as taxable wages on your income tax return.  In short, non-cash fringe benefits that are also non-taxable are a way for you to have your soda and drink it too.

Understanding income reporting on your paystub and Form W-2

Now that you know the distinction between gross wages and gross taxable wages you’re in a better position to understand your paycheck.  For example, gross wages ($4,166.67 based on the figures above) on your pay stub should be labeled something along the lines of “Salary,” “Regular Salary,” or “Wages.”  Likewise, your gross taxable wages ($4,181.67 based on the figures above) should also appear on your paystub and be labeled something like “Current,” “Current Taxable Wages,” “Taxable,” or “Taxable Wages.”

Using the principles discussed above you should also have a better understanding of your W-2, the tax form that your employer mails to you at the beginning of each year (e.g. January 2011) telling you how much you need to report in wages on your April 15th tax return for the year that just ended (2010).  So in our example would you expect your taxable wages for the year to be $50,000, right?  No!  Remember, that’s just your salary.  Your taxable wages in box 1 of Form W-2 should be $50,180, equal to your $50,000 base salary plus $180 of non-cash taxable fringe benefits relating to your life insurance coverage ($15 a month x 12 months).  Also, the $180 value of your non-cash taxable life insurance fringe benefit should be separately reported on your W-2 at line 12.

Why knowing how to calculate your gross taxable wages is important

So is all of this small potatoes?  After all, is it really the end of the world if you don’t understand why your taxable income is $15 higher per paycheck than your salary?  No, $15 of extra taxable income a month (which would translate into $2-$4 of extra tax) probably shouldn’t rate high on your list of things to lose sleep over.  However, what if you had more significant non-cash taxable fringe benefits such as the use of a company car, your company paid club dues on your behalf, or you got to take a personal trip on the company plane?  In such cases the value of your non-cash taxable benefits could be significant, and if that’s not something you take into account then you could be in for a nasty surprise when you get your tax bill.

But what if you’re like most regular people you don’t get a company car or have the opportunity to jet around the country in the company plane?  What if all you ever have is that $15 or so difference a month between your gross wages and your gross taxable wages?  Would it really be that big a deal not understand where that difference came from?  As I said before, on the surface it wouldn’t seem to matter very much.  However, in my experience the difference in confidence between those who sort of understand their finances and those who really understand their finances makes a big difference in their ability to make confident, sound, and decisive financial decisions.  And as further articles will show, if you don’t understand the difference between your gross wages and your gross taxable wages then you’ll never fully grasp what’s going on with the rest of your paycheck.

[1] The figures in this example are drawn from my introductory article on how to understand your paycheck.

[2] This example assumes you’re paid once a month, but the same principles apply if you are paid bi-monthly, weekly, etc.

[3] Source: Internal Revenue Code Section 79.