Your gross pay may equal your taxable pay, but sometimes your taxable pay is less because of pre-tax exemptions or deferred compensation. Your gross pay is more than your taxable pay if you contribute to an employer-sponsored retirement plan, such as a 401k or an Internal Revenue Service-qualified flexible spending expense account. You designate amounts to go to these accounts before taxes are deducted from your gross pay.
If your employer offers a contributory retirement plan, such as a 401k, your contributions are made pre-tax, lowering your taxable pay. Your taxable pay will equal your gross pay minus contributions to IRS-qualified retirement plans. Your employer typically matches, up to specified percentages, your contributions to these plans. Employer contributions are also not considered additions to your gross pay. Your regular gross pay will not be taxed for these contributions to tax-free or deferred programs.
Flexible Spending Accounts
Flexible spending accounts, sponsored by your employer, come in various types. While most of these help you meet medical expenses, such as co-pays or treatments not covered by your health plan, you may have access to IRS-qualified programs that allow you contribute some of your gross pay for child care expenses or similar costs. Your contributions lower your gross pay, but you must spend all pre-tax monies by the end of each calendar year or you forfeit your balance.
You benefit from these pre-tax deductions by paying lower federal and state income taxes and decreased payroll taxes. You have money to pay non-covered medical expenses, such as co-pays, or child care costs. If you contribute to IRS-qualified retirement plans, such as 401k programs, you defer taxation until you withdraw these funds, usually after you retire and have lower gross income.
Your employer may offer pre-tax or tax-deferred options to save tax money that results in benefits to the company. When your W-2 earnings decrease, it saves your employer her portion of payroll taxes and state unemployment taxes. Employer benefits vary by the amount of compensation you and other employees earn, because the U.S. has a progressive tax rate system, with higher tax rates on higher income.
Your pay stubs will show your gross pay and, if you contribute to retirement or flexible spending plans, your taxable pay. The year-to-date totals will also display your gross and taxable earnings for the calendar year as of the date of your pay stubs. Your gross and taxable earnings will show on your year-end W-2 that your employer gives you. You need only report your taxable pay on your federal and state tax returns.
Video of the Day
- Comstock Images/Comstock/Getty Images