W-3 box 1 less than box 3 or box 5?

[braathwaate]

The W-3 generated by Paywindow for one of my databases has box 3 (social security wages) equal to box 5 (medicare wages), but box 1 (wages, tips, other compensation) amount shows a lesser amount. The employer totals report shows YTD equal to box 3/5, so I do not know where this lower box 1 amount is coming from. Any ideas?

[Paul Mayer]

I'm guessing that you have a Deduction set up as Exempt from FIT as box one is wages subject to FIT.

[lclark]

The W-3 generated by Paywindow for one of my databases has box 3 (social security wages) equal to box 5 (medicare wages), but box 1 (wages, tips, other compensation) amount shows a lesser amount. The employer totals report shows YTD equal to box 3/5, so I do not know where this lower box 1 amount is coming from. Any ideas?

I have this same issue for two of 5 employees, with all deductions set to N.

[Paul Mayer]

I have this same issue for two of 5 employees, with all deductions set to N.

Box 1 is wages subject to FIT during the year those employees were exempt in one of more settings from FIT be it a deduction that was exempt from FIT or their taxable settings were set as exempt from FIT.

[braathwaate]

I found the problem. The employee record had Exempt From Federal and State set to Y (the employee had requested no state or federal withholding). This causes the box 1 wages on the W-2 to be blank. So when the W-3 totals them up, it must assume that the blank is zero and the W-3, box 1 wages for all employees become less than box 3/5. Neither the W-2 nor the W-3 can be accepted by the SSA in this condition.

Unless someone knows how to set up an employee properly to be exempt from federal and state withholding and still generate valid W-2 and W-3 forms, the closest workaround I could up with is setting the number of deductions to 20, although this still creates some state tax withholding for a normal 40 hour workweek in Colorado, so staff will have to be informed to manually zero out the federal and state withholding when creating paychecks.

[Paul Mayer]

I found the problem. The employee record had Exempt From Federal and State set to Y (the employee had requested no state or federal withholding). This causes the box 1 wages on the W-2 to be blank. So when the W-3 totals them up, it must assume that the blank is zero and the W-3, box 1 wages for all employees become less than box 3/5. Neither the W-2 nor the W-3 can be accepted by the SSA in this condition.

Unless someone knows how to set up an employee properly to be exempt from federal and state withholding and still generate valid W-2 and W-3 forms, the closest workaround I could up with is setting the number of deductions to 20, although this still creates some state tax withholding for a normal 40 hour workweek in Colorado, so staff will have to be informed to manually zero out the federal and state withholding when creating paychecks.

That is a major problem, there are not many that are exempt from FIT like clergy at a church. All of your payroll transactions are stored with the exempt flag and changing it in the employee's record will not change the reports. The way to stop deductions by setting to 20 exemptions is correct to show the taxable wages. But too many employers get burnt when an employee tells them "I'm exempt from taxes because I am over 65." which is not true, as long as they work they must pay taxes on their earnings.

[braathwaate]

I didn't say the employee was exempt from FIT, just FIT withholding. If the employee claims exempt from FIT withholding on the W-4, the employer is obligated to do so. This practice was common up until 2020, and continues to this day on the 2020 W-4, as per these instructions from the W-4:

Exemption from withholding. You may claim exemption from
withholding for 2020 if you meet both of the following
conditions: you had no federal income tax liability in 2019 and
you expect to have no federal income tax liability in 2020. You
had no federal income tax liability in 2019 if (1) your total tax on
line 16 on your 2019 Form 1040 or 1040-SR is zero (or less
than the sum of lines 18a, 18b, and 18c), or (2) you were not
required to file a return because your income was below the
filing threshold for your correct filing status. If you claim
exemption, you will have no income tax withheld from your
paycheck and may owe taxes and penalties when you file your
2020 tax return. To claim exemption from withholding, certify
that you meet both of the conditions above by writing “Exempt”
on Form W-4 in the space below Step 4(c). Then, complete
Steps 1(a), 1(b), and 5. Do not complete any other steps. You
will need to submit a new Form W-4 by February 16, 2021.

[Paul Mayer]

I didn't say the employee was exempt from FIT, just FIT withholding. If the employee claims exempt from FIT withholding on the W-4, the employer is obligated to do so. This practice was common up until 2020, and continues to this day on the 2020 W-4, as per these instructions from the W-4:

Exemption from withholding. You may claim exemption from
withholding for 2020 if you meet both of the following
conditions: you had no federal income tax liability in 2019 and
you expect to have no federal income tax liability in 2020. You
had no federal income tax liability in 2019 if (1) your total tax on
line 16 on your 2019 Form 1040 or 1040-SR is zero (or less
than the sum of lines 18a, 18b, and 18c), or (2) you were not
required to file a return because your income was below the
filing threshold for your correct filing status. If you claim
exemption, you will have no income tax withheld from your
paycheck and may owe taxes and penalties when you file your
2020 tax return. To claim exemption from withholding, certify
that you meet both of the conditions above by writing “Exempt”
on Form W-4 in the space below Step 4(c). Then, complete
Steps 1(a), 1(b), and 5. Do not complete any other steps. You
will need to submit a new Form W-4 by February 16, 2021.

By marking him or her as Exempt from FIT, none of those wages will appear on the W2 Form nor the 941 Form as box 1 on the W2 is ONLY Wages Subject to FIT. On the 941 Form, Box 2 is ONLY for wages subject to FIT as well.

[braathwaate]

So clearly marking an employee as Exempt from FIT is something no one should ever do, because wages are always subject to FIT. However, it would be useful to mark an employee as exempt from FIT withholding, because using the number of deductions method is insufficient.

[Paul Mayer]

So clearly marking an employee as Exempt from FIT is something no one should ever do, because wages are always subject to FIT. However, it would be useful to mark an employee as exempt from FIT withholding, because using the number of deductions method is insufficient.

No it is used for Pastors and Priests and required for non-employee payees (1099-MISC Payees). You can always type a zero in and press the Tab Key to take the tax out and leave the taxable wages to be reported too.