Just in time for tax crunch time, Gail explains what all those little boxes on your W-2 Statement mean.
Dear Friends-
I hate to be the bearer of bad news, but there’s less than a month to go if you plan to file your federal income tax return by this year’s April 17th deadline.* (The deadline for your state may be a day earlier, so be sure to check.)
Even if you use a software program, knowing what information needs to be entered in the various boxes or on each line can be confusing. There’s a reason the free tax guide for individuals — IRS Publication 17, "Your Federal Income Tax" — runs to nearly 300 pages! (Recommendation: download this at www.irs.gov and keep a copy next to your bed for those nights you can’t get to sleep. You can also order it by phone if you’re willing to be put on hold for a half hour, as I was. The number is 1-800-TAX-FORM.)
Take something (theoretically) as basic as a W-2 statement. That’s the form an employer sends you (and the IRS) detailing the income you received and taxes that were deducted for the previous year. By law, all employers must send this no later than January 31st, so if you haven’t received yours yet, contact your payroll department immediately.
If you’re new to the workforce or are just trying to complete your tax return yourself for the first time, even the W-2 can be overwhelming. One of the first things you notice is that there are multiple boxes that refer to "income" of one kind or another.
Box 1 is called "Wages, tips, other compensation." Box 3 lists "Social Security wages," while Box 7 contains "Social Security tips." On the other hand, Box 5, "Medicare wages and tips," combines both. Not to mentioned Box 8: "Allocated tips."
The folks at Intuit, maker of all things "QuickBooks," have dissected the W-2, explaining in plain English what (almost) every box is about. Click here for their handy breakdown. Just keep in mind that not all W-2s look alike. Although it will contain the same boxes, the form used by your employer or its payroll provider might be laid out slightly differently.
Accountant Regina Lian, a "QuickBooks" consultant, says if you’re employed, the
W-2 "is the starting point for determining what you owe in taxes." Although your knee-jerk reaction upon receiving this each year might be to toss it into a file labeled "Taxes," Lian recommends taking a couple of minutes to check it for accuracy.
"At payroll departments and payroll services, there is a lot of data entry that’s done with human input," says Lian. She adds, "At the end of the day, the individual is responsible for the correctness of their W-2 information. You’re the one who should be checking this against your pay stubs."
Translation: there’s a decent chance something may have been entered incorrectly. The sooner you request a corrected W-2 from your employer, the better.
The potential for a mistake on your W-2 increases if you work on an hourly basis or your salary changed during the year. Does Box 1 correctly reflect the number of hours you worked? If your raise took effect in September, does your W-2 show that you received this higher salary for four months instead of 12?
You can avoid the pressure and hassle of trying to get a corrected W-2 at the 11th hour by keeping an eye on your pay stubs throughout the year. Lian says she recently learned of a case involving an independent contractor. This individual noticed that the company had "mistakenly deducted taxes. It took four payroll runs to get it corrected."
It comes down to the complex and esoteric principal known in data processing circles as "GIGO" — Garbage In, Garbage Out.
Newby taxpayers are especially susceptible to the, "Golly gee-wiz, how could I possibly still owe more taxes?" phenomenon. This arises when they look at Boxes 2, 4 and 6 on the W-2 and realize how much has already been sent to the U.S. Treasury over the past year.
"People have a disconnect between what they see is withheld and understanding what their tax liability is," says Lian. They think that whatever amount their employer took out was enough and can’t understand why their tax return says they need to send even more money to the I.R.S.
Psssst: Your employer has no idea what your tax bill will be! What if you have a second job? Maybe you have zero dependants, but a co-worker earning the identical salary has three kids, so she gets a bigger deduction than you do. If you rent an apartment, but she’s paying on a mortgage, this will also result in her tax bill being lower.
Remember that the amount your employer withheld was based on information supplied by you when you submitted a related payroll form — the W-4. (More on this later.)
Helpful Hint: Do you work in a job where you receive tips? "If you don’t want to send up a red flag" to the I.R.S., Lian says be sure "something" appears in Box 7. In her words, "You would do yourself a service to ask your employer to record some amount."
And, no, you don’t get to write this in yourself.
While it’s important to open and check your W-2 when you receive it, don’t treat it casually. It contains a lot of very sensitive, personal information — your Social Security number, for instance. This is definitely something that you do not want identity thieves to gets their hands on.
Finally, Lian suggests you use your 2006 W-2 statement to do some planning for 2007. Does the government owe you money? Then reduce the amount of your withholding by filing a revised W-4 with your payroll department. In Lian’s words, "Why let the government use your money?"
If you want to reduce your tax bill, look at ways to reduce the amount that appears in Box No. 1. The easiest thing to do is increase the contributions you’re making to an employer-sponsored retirement plan. If it makes sense for you and your company offers one, consider putting money into a "flexible spending account." In addition to medical expenses, money in some FSAs can be used to pay commuting expenses with pre-tax dollars. Talk with a financial advisor about other options you might have such as a tax-deductible IRA.
And to keep better track of your income and deductible expenses over the year, consider using one of the many software programs available. Come this time next year, it will be a cinch to see if your W-2 accurately reflects the money you made and the taxes you paid.
Hope this helps,
Gail
*Even if you file for an extension and send in your tax return later this year, the deadline for making a 2006 contribution to an IRA is still April 17th.
If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.
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