What Are State Wages vs. Federal Wages?

The terms “state wages” and “federal wages” are important for understanding your annual tax obligations. While they often appear similar, the differences can affect the amount of state income tax you owe. Correctly calculating these figures is part of payroll compliance for employers and is needed for accurate tax filing by employees. State wages represent the portion of your earnings subject to a state’s income tax laws.

The Federal Baseline for Wages

Federal taxable wages are the starting point for most state tax calculations and are reported in Box 1 of your Form W-2. This figure includes your salary, bonuses, commissions, reported tips, and other compensation. This amount is calculated after certain pre-tax deductions are subtracted from your gross earnings. Common pre-tax deductions include contributions to a 401(k) or 403(b) plan, health insurance premiums, and funds for a Health Savings Account (HSA) or Flexible Spending Account (FSA). Conversely, taxable fringe benefits, such as group-term life insurance coverage over $50,000, are added to this calculation.

Common State Adjustments to Federal Wages

Most states with an income tax use federal adjusted gross income (AGI) as a foundation for their tax calculations but often require specific adjustments. This means certain types of income excluded at the federal level may be taxed by your state, or vice-versa. These modifications are the primary reason your state wages can differ from your federal wages.

A frequent adjustment relates to retirement plan contributions. While your contributions to a traditional 401(k) are pre-tax federally, some states do not allow this deduction. Pennsylvania, for instance, taxes employee contributions to 401(k) plans, making state wages higher than federal wages. New Jersey allows pre-tax 401(k) contributions but taxes contributions to other retirement plans, such as 403(b) and 457 plans.

Another area of divergence is the treatment of interest income from municipal bonds. Federally, interest earned from municipal bonds is tax-exempt. States generally exempt interest from bonds issued within their own borders but tax the interest earned from bonds issued by other states. This means if you own municipal bonds from another state, you may need to add that interest income to your state tax return.

States may also differ in their treatment of certain fringe benefits. An employer-provided benefit for education or transportation that is non-taxable under federal law might be considered taxable wages by a particular state. The result of these various additions and subtractions is a unique state wage figure.

Locating State Wages on Your W-2

Your Form W-2 clearly separates federal and state wage information. The total wages subject to state income tax are reported in Box 16, labeled “State wages, tips, etc.” Box 17 shows the total amount of state income tax withheld from your paychecks based on that wage amount.

When you receive your W-2, you can compare the amount in Box 16 with the federal wages reported in Box 1. If the numbers are different, it is a direct result of the state-specific adjustments your employer has accounted for. For instance, if a state taxes 401(k) contributions, your Box 16 wages will be higher than Box 1 wages by that amount.

The amount in Box 16 is the wage figure you will report to your state’s tax authority. Any discrepancy between Box 1 and Box 16 is not an error but a reflection of the different tax laws at the federal and state levels.

Multi-State Employment Scenarios

The calculation of state wages becomes more complex when you live in one state and work in another, or if you work in multiple states. In these situations, specific rules determine which state can tax your income. The general sourcing rule dictates that income is typically taxed by the state where the work is physically performed.

If you live in State A but commute to work in State B, your employer in State B is required to withhold income taxes for State B. You must file a resident tax return in State A and a non-resident return in State B. To prevent double taxation, your home state usually provides a tax credit for the taxes you paid to the other state.

To simplify this process, many neighboring states have tax reciprocity agreements. These pacts allow a resident of one state to work in the other and only pay income tax to their state of residence. For this to apply, the employee must file a specific exemption certificate with their employer. If an agreement is in place, your W-2 should only show wages and withholding for your home state.