Why Are My State Wages Lower Than Federal?
Understand the nuanced differences in how state and federal governments define taxable income, which explains why your reported state wages may be lower.
Finding that the state wage figure on your tax documents is lower than the federal amount can be confusing, but it is not necessarily an error. This situation arises from differences in how federal and state governments treat certain employee deductions. Your W-2 reports taxable wages after pre-tax deductions have been made, and this discrepancy occurs when state and federal rules differ on what qualifies as a pre-tax deduction.
The Foundation of Taxable Wages
Gross wages represent the total amount of money earned before any taxes or deductions are taken out. From this amount, employers subtract pre-tax deductions, which are payments for specific benefits that are not subject to income tax. The result is your taxable wage, the figure used to determine your income tax liability.
Your W-2 form shows these figures in different boxes. Box 1, labeled “Wages, tips, other compensation,” shows your total taxable wages for federal income tax purposes. This amount does not include contributions to most pre-tax benefit plans. Separately, Box 16 shows the wages that are subject to state income tax.
A discrepancy between Box 1 and Box 16 occurs because federal and state governments do not always agree on which deductions are “pre-tax.” A deduction might reduce your taxable income at the state level but not at the federal level. This results in a lower wage amount in Box 16 compared to Box 1.
Primary Reasons for Lower State Wages
The primary reason for lower state wages compared to federal wages involves contributions to specific government-sponsored retirement plans. This is common for public sector employees, such as teachers, state government workers, and other municipal employees. Some states have established pension or retirement systems where employee contributions are considered pre-tax for state income tax purposes.
In these arrangements, mandatory contributions to a state pension plan are subtracted from gross wages before state income tax is calculated, reducing the wage amount in Box 16. The federal government, however, does not provide the same tax-deferred treatment for these state-level plans. For federal purposes, these same contributions are included in the employee’s taxable income.
Consequently, the amount in Box 1, representing federal wages, remains higher because it includes the retirement contributions that the state allowed you to deduct. This difference in tax law means your state taxable income is legitimately lower than your federal taxable income. While less frequent, other state-specific fringe benefits not recognized by the federal government can also contribute to this disparity.
Investigating the Discrepancy on Your Forms
If you notice your state wages are lower than your federal wages, you can investigate by reviewing your financial documents. The first place to look is your final, year-end pay stub. This document provides a detailed breakdown of your earnings and all deductions, so look for items related to retirement, pension plans, or other state-specific benefits.
After examining your pay stub, turn to your Form W-2, specifically Box 14, labeled “Other.” Employers use Box 14 to list the amounts of state-specific deductions, such as mandatory contributions to a state retirement plan. You may see a description like “State Retirement,” “STRS” (State Teachers Retirement System), or a code like “IRC414H” for these contributions.
The amount shown in Box 14 next to such a code often corresponds to the difference between your federal wages in Box 1 and your state wages in Box 16. If the details on your pay stub and W-2 do not provide a clear answer, contact your employer’s human resources or payroll department for an explanation.
The Opposite Scenario When State Wages Are Higher
It is more common for an employee’s state wages in Box 16 to be higher than their federal wages in Box 1. This occurs because some common pre-tax deductions for federal purposes are not recognized by certain states. For instance, contributions to a 401(k) or 403(b) retirement plan reduce your federal taxable income, but a few states do not allow this deduction.
Similarly, contributions to a Health Savings Account (HSA) are deductible at the federal level, lowering the wage amount in Box 1. However, some states do not conform to federal law regarding HSAs and do not permit this deduction. In these states, the amount you contributed to your HSA remains part of your taxable state wages.
These scenarios highlight the non-aligned nature of federal and state tax codes. Differences between federal and state wage boxes on a W-2 are a direct result of varying tax laws. The discrepancy is tied to how each government treats specific pre-tax deductions for benefits like retirement plans and health savings accounts.