How Subject Wages Differ from Taxable Wages—and Why It Matters

Taxable wages are all payments made to workers that are subject to local, state, and federal taxes, while subject wages are income after certain deductions that receive special tax treatments.

Wages are monetary compensation given to an employee or independent contractor for work done. Payment can be made at a fixed salary rate or hourly rate. This may seem simple, but there are different types of wages to consider for various types of withholding, the most common being taxable wages and subject wages.

Gross Wages

Gross wages or gross income is the amount you pay to your employee before non-taxable pay, such as business expenses, and are reimbursed and before any taxes are withheld. Various types of compensation, such as money, property, and services, may all be considered income, but in most cases, we will be talking about the total amount of money you pay your employee before anything is subtracted.

Taxable Wages

Taxable wages (or Personal Income Tax [PIT] wages) are cash payments and noncash payments that are subject to local, state, and federal withholding tax. Usually, your gross pay is taxable unless it is specifically exempted by law. Please note bonuses, overtime, and commissions are all taxable income.

Child support and welfare are examples of non-taxable wages. You can find a list of these exemptions in Publication 525, Taxable and Nontaxable Income.

Net Pay

Once an employee’s wages are taxed, the remainder is the employee’s net pay. You will list both gross pay and net pay on your employee’s W-2 form for the year.

Subject Wages

Certain types of pre-tax deductions have special treatment when it comes to taxes. Once the amount is deducted, you are left with the subject wage, meaning that is the wage subject to tax for a particular purpose, such as FUTA (unemployment taxes) and FICA (Social Security taxes and Medicare taxes).

An example would be deductions under a Section 125 plan, a tax-advantaged benefits plan often referred to as a Cafeteria Plan because it lets employees pick from a variety of pretax benefits as one might choose among food in a cafeteria. According to the IRS, “A cafeteria plan is defined in §125(d)(1) as a written plan maintained by an employer under which all participants are employees, and the participants may choose among two or more benefits consisting of cash and qualified benefits.”

Common benefits in a cafeteria plan might include health insurance premiums, health savings accounts, dependent care assistance, and adoption assistance, among others. An employee can deduct the amounts they pay into these accounts in eligible contributions from their income, and the reduced figure is the subject wage on which certain taxes are based, such as Social Security and Medicare taxes. These deductions can also be excluded for FUTA.

States consistently do not follow federal Income tax laws, so it’s important to research each state when it comes to subject wages.

Regarding Social Security, if you look at Box 3 of an employee’s Form W-2, the amount represents taxable wages subject to Social Security taxes. Certain deductions reduce an employee’s wages that are taxable for Social Security, such as the pre-tax medical/dental and vision insurance or pre-tax parking deductions, among others. However, there is also a yearly cap on Social Security wages, and employees whose incomes exceed that cap do not get a deduction for Social Security taxes for the remainder of the year.

How Do Subject Wages Benefit Employees and Employers?

Both employers and employees can benefit from the tax breaks due to subject wages. Employees can use pre-tax dollars to pay for eligible expenses, thus lowering their taxable income. Employers can reduce payroll taxes (FICA and FUTA) because eligible pre-tax contributions are not subject to these taxes.