The Internal Revenue Service would like to share the benefits of completing a payroll reconciliation
prior to filing your final Form 941, Employer's Quarterly Tax Return or Form 944, Employer's Annual
Federal Tax Return, as well as annual Forms W-2, Wage and Tax Statements and Form W-3, the
Transmittal of Wage and Tax Statements.
Employers who reconcile payroll can avoid discrepancies by ensuring employees' wages and taxes
reported to both the Internal Revenue Service, IRS, and the Social Security Administration, SSA,
Completion of the payroll reconciliation usually results in more accurate payroll wages and taxes
reported on quarterly Forms 941 or annual Form 944, fewer Forms W-2C, Corrected Wage and Tax
Statements are needed, and fewer notices are received from the IRS or SSA.
You will need data from your payroll accounting system to complete the reconciliation.
The data should include: total gross payroll for the year, annual totals for each employee's pretax
and after-tax payroll deduction, if any employees were paid over the Social Security wage base, you
will need to compute the total amount of their individual wages that exceed the wage base limit.
The wage base limit is announced annually.
You will also need the quarterly Forms 941, or an annual Form 944.
And finally your Forms W-2 and Form W-3.
If filing electronically, the Form W3 will be reflected in the totals of Form W2.
Step one is to validate the gross payroll amount.
Gross payroll includes all payments and benefits given to your employees including: salaries, hourly
pay and overtime, sick and vacation leave, allowances like vehicles and uniforms, taxable group term
life insurance, any other payments like bonuses or taxable benefits unique to your employees.
Verify that all payments and non-cash benefits provided to or for employees have been considered in
the determination of their compensation.
Step two is to verify all the amounts for pre-tax and after-tax deductions are included and
correctly coded in your payroll system to be subtracted from gross payroll as applicable to arrive
at total Medicare, Social Security, and federal income tax wage amounts.
Examples of pre-tax deductions could include: health and dental insurance, medical flexible spending
arrangements, dependent care, and certain retirement plan contributions.
After-tax deductions could include such items as: employee's share of insurance policies outside
cafeteria plans, union dues, garnishments, employment taxes, and other items unique to your
Step three is to ensure the amounts on the Form W-3 are the total amounts from the W-2.
Add the amount in Box 5 for all Forms W-2 for Medicare wages and tips and compare it to the total
Form W-3 amount.
Also do this for Box 3, Social Security Wages, and Box 1, Wages, Tips, and Other Compensation.
Also, review the taxes withheld in Boxes 2, 4, and 6.
If wages include tips, compare Social Security Tips found in Box 7.
If they do not match, Forms W-2 wage amounts should be compared to individual employees' gross
payroll minus their tax deductions and Social Security wage base limit adjustment amount as
Multiplying the wage amounts times the applicable employee tax rates should match those amounts
shown as Medicare and Social Security taxes on the Form W-2.
Step four is to determine if the Medicare, Social Security, and Federal Income Tax wages, as well as
applicable taxes withheld, reported on the quarterly Forms 941 or annual Form 944 match those on the
Form W-3 for that year.
Note: The Form 941 or Form 944 amounts for Medicare taxes withheld and Social Security taxes
withheld need to be divided by two to adjust for the employer's share of these taxes to match the
Form W-3 amount.
If there is a discrepancy between the Forms 941 or Form 944 and the Form W-2 totals, you may receive
a notice from the SSA or IRS asking for an explanation.
There may be valid reasons for Forms 941 or Form 944 and the W-2 amounts not to match and you should
have records to document what those reasons are.
See Publication 15, Employer's Tax Guide, for more information.
Let's look at an example.
Records document a gross payroll of $1 million and the following items: health insurance of
$120,000.00, dental insurance of $80,000.00, Social Security wage base limitation adjustment of
$50,000.00, and retirement plan contributions of $150,000.00.
We begin by reconciling the Medicare wages and tips, usually the largest compensation figure
Review the pre-tax categories to determine which ones are exempt from Medicare and subtract them
from the gross payroll amount.
In our example they are: health insurance of $120,000.00 and dental insurance of $80,000.00,
totaling $200,000.00 to be subtracted from the $1 million gross payroll amount.
This results in $800,000.00 of taxable Medicare wages and tips that should be recorded in Box 5 of
Form W-3 or the total of Box 5 of Form W-2s, and be the total of Medicare wages on the Forms 941 or
Box 6 of the Form W-3 should show $11,600.00 of employee Medicare taxes withheld, and $23,200.00
should be the total of Lines 5(c) Column 2 of the Forms 941 or Line 4(c) Column 2 of the 944.
Next we will reconcile the Social Security wages.
The following pretax deductions are tax exempt from Social Security wages and subtracted from the $1
million gross payroll amount: health insurance of $120,000.00, dental insurance of $80,000.00, and
the Social Security wage base limitation adjustment amount of $50,000.00, totaling $250,000.00 to be
subtracted from the $1 million gross payroll amount.
This results in $750,000.00 taxable Social Security wages that should be reported in Box 3 of the
Form W-3 or the total Box 3 of the Form W-2s and be the total of Social Security wages on the Forms
941 or Form 944.
Box 4 of the Form W-3 should show $46,500.00 of employee Social Security taxes withheld and
$93,000.00 should be the totals of Lines 5(a) Column 2 of the Forms 941 or on Line 4(a) Column 2 of
the Form 944.
Note: If tip amounts are involved, please see the instructions for Box 7 of the Form W-3, Line 5(b)
Column 1 of the Form 941, or Line 4(b) Column 1 of the Form 944.
The same reconciliation process should be completed for this item.
Lastly, the reconciliation of Wages, Tips and Compensation, also referred to as Federal Income
Taxable, FIT, wages will be completed in the same manner as shown for the Medicare and Social
The following pretax deductions are exempt from FIT wages and subtracted from the $1 million gross
payroll amount: health insurance of $120,000.00, dental insurance of $80,000.00, and the retirement
plan contributions of $150,000.00.
Thus, $350,000.00 is subtracted from the $1 million gross payroll amount.
This results in $650,000.00 of taxable federal income wages that should be reported in Box 1 of the
Form W-3 or the total of Box 1 of the Form W-2s and be the total of Lines 2 of the Form 941 or on
Line 1 of the Form 944.
Now that we have completed the payroll reconciliation, here are a few final tips for more accurate
payroll information reported to the government and sent to your employees.
Number one, make sure that any late adjustments to payroll that are included in the fourth quarter
Form 941 or annual Form 944 are reported on the Forms W-2 and W-3.
Number two, complete the payroll reconciliation once the year-end payroll is finalized and prior to
sending the fourth quarter Form 941 or the annual Form 944 to the IRS and sending the Forms W-2 to
employees to prevent them from having to file amendments and delay the employees' ability to file
their personal income tax returns.
Number three, annually review Section 12 of the Publication 15, Employer's Tax Guide, Publication
15-B, Employer's Tax Guide to Fringe Benefits, and Publication 963, the Federal State Reference
Guide that provides state and local government employers a comprehensive reference source on Social
Security and Medicare coverage.
And also federal tax withholding issues.
And finally, if you receive a letter from the IRS about a discrepancy in your reported wages, call
the telephone number listed on the letter for assistance.
We hope you have found this information on completing the payroll reconciliation helpful.
For more information on these forms and filing requirements, visit us online at irs.gov.