How to Read a w-2 Form

Ever wonder how to read your W-2 Form and why it is important?

Did you know that when I prepare projections for estimated taxes each quarter one of the things that I request is the latest payroll stub?

This is because I understand the complexity of the Form W-2 and how the anticipated Boxes 1 and 2 at the end of the year can play into whether any payments are due quarterly or if enough funds have been paid to cover the taxes due.

This is a roundabout way of saying that by understanding how to read a Form W-2, I can better project and understand tax impacts.

Ok, ok, I get it I jumped right into a lot of jargon! I guess I should start off the conversation with…

What is a Form W-2? A W-2 Form is the U.S. Wage and Tax Statement for individuals which are employed. It is as simple as those words – it is the wage and/or salary information reported to you for the year by a company that employs you – butinevitably confusions come up when dealing with a Form W-2.

Tax season can be a scary time for so many people. It is a time to find out did you pay enough tax, i.e. withholdings, into the US Treasury to get a refund, or do you owe!

On January 31^st each year businesses are required to issue to their employees, and file with the Internal Revenue Service (IRS) and Social Security Administration (SSA) the W-2 Form.

Based on this information the IRS updates your wage and income information for the year, thereby keeping a record of what they know you should be reporting on your income tax return, and the SSA records your social security wages and Medicare wages – all important datapoints for benefits later in life.

Without making this form seem scary or more confusing, let’s go over the highlights of the Form W-2, so you understand a little more about filing your income taxes and the intersection with estimated payments.

Box 1: Wages, bonuses, commissions, tips and other compensation

This is the starting point. You know you walk into a new position, or you are given a raise, the number that you will be paid for your work – well, that is Box 1! For example, you make $50,000 a year in wage income. The first complication of this box comes with increases to it for stock options, various commissions, and bonuses…

…and, Box 1, is also increased for various fringe benefits (think personal usage of vehicle, group term life insurance), “non-accountable” expense reimbursements, and if you are a 2% owner of an S Corporation, you have to include your health insurance premiums paid by the S Corporation.

Oh wait, Box 1 is not done yet! Box 1, also gets DECREASES! What are the decreases?

• Elective deferrals to retirement planning – this means your contributions to 401(k), 403(b), or 457 government retirement plans. It should be noted that if you are offered a Roth 401(k) the amount you contribute to that portion of your retirement will not reduce Box 1.
• Pre-tax payroll deductions like health insurance, FSA plans for childcare expenses and medical, as well as, HSA contributions.

Box 3 and 5: Wages subject to social security and Medicare

These boxes are important because they report to the SSA, allowing you to keep track of what your benefits will be by the time retirement comes (let’s not start the conversation about whether it will be around…)

Box 3 is the social security wage amount and it is capped at $142,800 (2021). This means that you will only get taxed at 6.2% up to capped amount.

Box 5 is the Medicare wage and there is no cap on it. Meaning you get taxed 1.45% on this full amount.

…similar to Box 1, there are additions and subjections.

• Additions: any pre-income tax contributions to retirement are added back to Box 3 and Box 5.
• Subtractions: any S Corporation health insurance premiums included in Box 1 wages

Alright, those are the big figures. Next let’s go over the tax withholdings.

Boxes 2, 4, and 6: Tax withholding amounts

These are amounts paid into the respective taxing authorities during the year, that then are reconciled at the end of the year when you file your income tax return.

**Box 2 is a VERY important box. This is the amount that you have paid into cover your taxes during the year. All year your salary from your employer includes pre-payments to your taxes!**

Phew, ok, so are you confused? Most likely…let’s take a step back.

If you are confused let’s discuss why all of this is important. The vast majority of people in the United States are employed. However, there is a growing number of individuals which also have side-hustles or are growing businesses.  When having side hustles or growing businesses you need to plan for estimated payments and tax withholdings. Understanding the impact of your Box 1 and Box 2 – as seen through reviewing your payroll stubs throughout the year – can substantially increase your clarity + empowerment.

If you can learn how to read your Form W-2 and then in turn your payroll stubs, then you can better prepare yourself for your estimated payments.

The basic idea and takeaway is that Box 1 is your total income for the year from a salaried position (either part-time or full-time), and it includes reductions for health insurance and retirement. Box 2 is the tax withholding on the total income.

How does this correlate to your latest paystub?

When you look at your latest paystub you will be able to take your total gross income and reduce for things like your health insurance and your retirement, while also adding back various other additions (see above), and that will allow you to project what the Form W-2 will be come the end of the year. By knowing this information you will have a better idea and understanding of whether you are up to speed on estimates or you should pay quarterly estimated tax payments.

However, I will tell you that this takes time to understand. Don’t get discouraged if this entire post gave you more anxiety. Hang around, check out my Instagram posts and Reels  for more information, and don’t forget to get in touch if you are ready for more support!