Payroll in Practice: 1.27.2025

Question: As part of the year-end closing process, a company wants to reconcile the amount reported on the annual Form 940’s Line 3, total payments to all employees, with the total amounts reported on the quarterly Forms 941. Should the amount on Form 940’s Line 3 equal the amounts on Form 941’s Line 2, wages, tips, and other compensation, or Line 5c, taxable Medicare wages and tips?

Answer: The amount reported on Line 3 of Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, might differ from the total reported on either Line 2 or Line 5c on the four Forms 941, Employer’s Quarterly Federal Tax Return, filed for the calendar year.

Form 941, Line 2, wages, tips, and other compensation, should report wages subject to income tax, including taxable amounts that are not subject to income tax withholding, such as employer-paid premiums on excess group-term life insurance.

The amount reported on Line 2 might also differ from the amounts reported for Social Security and Medicare wages and tips reported on Lines 5a to 5d of Form 941. Certain items, such as employee pretax contributions to a 401(k) plan, are subject to Social Security and Medicare taxes but not income tax. Additionally, the amount for Social Security wages would not include amounts paid to employees over the Social Security wage base for the year.

Form 940, Line 3, total payments to all employees, should include all payments made for employee services. This includes payments that are not subject to FUTA tax. For example, Line 3 should include such items as Section 125 benefits and employer contributions to a 401(k) plan, even though those amounts are not subject to FUTA tax. The Form 940 instructions provide examples of amounts to include on Line 3. Including non-FUTA wages on Line 3 will create differences from the amount of Social Security and Medicare wages reported on Form 941, Line 5c.

There are some differences between the definition of FUTA wages and Social Security and Medicare wages. For example, the cost of the first $50,000 of employer-provided group-term life insurance is exempt from income, Social Security, Medicare, and FUTA taxes. Any excess coverage over that amount paid for by the employer is subject to Social Security and Medicare taxes but is not subject to FUTA tax.

Certain types of employees are subject to Social Security and Medicare taxes but not FUTA tax. Examples include children ages 18 to 20 who are employed by their parents and certain statutory employees, such as full-time insurance sales representatives who are paid on a commission basis.

Form 940, Line 4, payments exempt from FUTA tax, reports the total amount of payments for items included on Line 3 that are not subject to FUTA tax. These items are exempt because do not fall under the definition of FUTA wages. This includes payments for health and accident insurance, excess employer-paid group-term life insurance, and employer contributions to retirement plans.

Payments made as compensation for services that are not included in the definition of employment for FUTA purposes, such as wages paid by a 501(c)(3) organization, should also be included on Line 4. The instructions for Form 940 provide examples of common payments that are not subject to FUTA tax.

Form 940, Line 5, reports the wage amounts paid to employees that exceed $7,000, since these amounts are exempt from FUTA tax. Wages that were previously excluded for FUTA-exempt employees, such as those of a 501(c)(3) organization, are not included in this amount. Line 6 calculates the total amount of exempt FUTA wages for employees by adding the amounts on Lines 4 and 5. The difference between Lines 3 and 6 is the amount of wages subject to FUTA tax, which is reported on Line 7.

The Line 7 amount can be verified by multiplying $7,000 by the number of employees who received FUTA-taxable wages of at least $7,000 and adding to that the amount of FUTA-taxable wages paid to employees who were paid less than $7,000 during the year.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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