Box 1 (Wages, Tips and Other Compensation) represents the amount of compensation taxable for federal income tax purposes while box 3 (Social Security Wages) represents the portion taxable for social security purposes and box 5 (Medicare Wages) represents the portion taxable for Medicare tax purposes.
One of the most common differences between box 1 and boxes 3 and 5 is the amount of employee contributions to deferred compensation plans such as traditional 401(k) and 457. In the year the contributions are made, deferred compensation contributions reduce the employee's taxable income for income tax purposes, but not for social security or Medicare taxes.
NOTE: Employee contributions to deferred compensation plans are indicated on Form W-2 in box 12; code D for traditional 401(k) and code G for 457.
Social Security wages are those earnings that are subject to the Social Security portion of the FICA tax. Employers must withhold Social Security and Medicare taxes from wages paid to both hourly and salaried employees. These two taxes are collectively known as Federal Insurance Contributions Act (FICA) taxes.
FICA taxes are due on wages paid for "services performed as an employee in the United States, regardless of the citizenship or residence of either the employee or the employer," according to the IRS. Anyone working as an employee in the U.S. must have Social Security and Medicare tax withheld from wages, at least to some extent.
What Are Social Security Wages?
Social Security wages are the portion of earnings that are subject to the FICA tax. These wages are used by the Social Security Administration to determine Social Security benefit calculations at retirement, and they're subject to the Social Security portion of the FICA tax.
How the Social Security Tax Works
The FICA tax is calculated on the gross pay of an individual.
- The employee's gross pay is calculated for the pay period, depending on whether they're salaried or hourly workers.
- The gross pay amount is used to calculate withholding for federal and state income taxes based on the employee's W-4 form.
- The gross pay amount is also used to calculate withholding for Social Security and Medicare taxes.
The total withholding for FICA taxes is 15.3% of the employee's gross pay. The employee and the employer each contribute half.
Note
The FICA withholding amount for an employee is 7.65% of gross income: 6.2% for Social Security and 1.45% for Medicare.
What's Included in Social Security Wages – And What's Not
Some common types of compensation payments made to employees are exempt from being included as Social Security wages. They're not subject to FICA tax.
- Some disabled worker wages paid after the year in which the worker was entitled to collect disability insurance
- Employee business travel expenses reimbursed for amounts not exceeding the specified government rate for per diems or the standard mileage rate
- Compensation paid to family employees under age 18, or age 21 for domestic work
- Some"excess" fringe benefits that are taxable on an excess of the fair market value of the benefit over the sum of an amount paid for it by the employee and any amount that's excludable by law
- Employee insurance
- Payments to partners of a partnership
- Employer contributions to qualified retirement plans
- Payments to statutory non-employees such as qualified real estate agents and direct sellers
- Tips under $20 a month
- Workers compensation benefits
Additionally, earnings are only taxable for the Social Security portion of the FICA tax up to a certain maximum, which changes each year. Earnings begin accumulating again toward this "wage base" on January 1 of the next year.
Note
The Social Security wage base is indexed for inflation so it can be expected to increase a bit annually.
Federal Income Tax Withholding vs. Social Security Wages
The list of payments to employees that aren't included in FICA tax can be different from the types of payments that aren't included in income tax calculations. Some payments may be exempt from federal income tax withholding but taxable as Social Security wages.
| Income Tax Withholding | FICA Tax Withholding |
| Wages paid by a parent to a child are taxed. | Wages paid by a parent to a child are not taxed if the child is younger than age 18, or age 21 for domestic workers. |
| Payments to statutory non-employees are taxable for income tax purposes. | Payments to statutory non-employees are not subject to the FICA tax. |
| It applies to all earnings. | Social Security is taxed only on the first $137,700 in earnings annually as of 2020 and $142,800 in 2021. |
The instructions for completing Form W-2 have a list of payments that must be included for federal income tax purposes. IRS Publication 15 (Circular E) also includes a detailed list of payments to employees and whether they're subject to income tax or includable in Social Security wages.
Social Security Wages Reported on Form W-2
You must report both wages subject to income tax and Social Security wages on the W-2 form you provide to employees and file with the IRS in January of each year. These can be different amounts and they must be entered correctly on the employee's W-2 form.
- Box 1: "Wages, tips, other compensation" is the amount that's taxable to the employee for federal income tax purposes. It's the amount entered on the employee's income tax return
- Box 3: "Social Security wages" is the amount that is subject to the Social Security tax and it's used by the Social Security Administration to calculate Social Security benefits
Tips are included in both wages subject to income tax and Social Security wages, but they're calculated separately and included in Boxes 7 and 8.
Do These Wages Affect the Self-Employment Tax?
Self-employed individuals must pay both halves of Social Security and Medicare taxes. They can't share them with their employers because they're effectively their own employers.
These taxes are called self-employment taxes when applied to independent contractors, sole proprietors, and other self-employed individuals. They're based on the net income of a business. The types of income that are included in Social Security wages are not relevant to self-employment taxes.
Key Takeaways
- Social Security wages are those earnings that are subject to the Social Security portion of the FICA tax. Not all compensation qualifies as Social Security wages.
- Employees pay 6.2% of gross earnings as the Social Security tax, and employers must match this amount.
- Only the first $137,700 in compensation annually is subject to the Social Security tax as of 2020. The threshold is $142,800 in 2021. Earnings over this wage base are tax-free for the remainder of the year.