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Nontaxable Compensation

What are tax free benefits?

Many benefits that are received from an employer are tax free (income not included in gross income and income taxes are not paid on it). An example of a tax free benefits is group health insurance paid for by an employer.

What are tax deferred benefits?

Other benefits are tax deferred. Retirement plan contributions are the most common form of tax deferred benefits. An employer's contributions to a qualified retirement plan are not included in the employee's income in the year the contribution is made. The money is taxed when withdrawn from the plan.

What is deferred compensation?

Deferred compensation or the part of pay that an employee contributes to a qualified retirement arrangement set up by an employer such as a 401k plan if treated as an employer contribution to a qualified plan and is not taxable until it is withdrawn. There is a limit to the amount of pay that can be deferred in this way. The limit in 2007 is $15,500 (see other section on deferred compensation). The amount of deferred compensation is shown in box 12 of Form W-2 with the code letter D.

Do I have to pay income tax on deferred compensation?

Deferred compensation is not included in the form W-2, box 1 because it is not subject to income tax.

Why are the amounts on W-2 boxes 1,3,and 5 different?

While deferred compensation is not subject to income tax, deferred comp is subject to social security and Medicare tax. Because of this, the Social Security and Medicare wages shown in boxes 3 and 5 of Form W-2 will be different from the wages shown in box 1.

Anytime there is a difference in the amounts in boxes 1, 3, and 5, look in box 12 of Form W-2 to determine the reason.


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