IRS Rules for Supplemental Wages Withholding
Supplemental wages can sometimes be taxed at a flat rate
Supplemental wages are paid to an employee in addition to his regular wages. They include things like vacation pay, bonuses, overtime, moving expenses, sick pay, severance pay, taxable fringe benefits, and even commissions.
That's the bright side of the equation. Everyone wants to receive those perks. But supplemental wages can be taxed differently than regular wages, and this can result in some taxpayers paying more.
Two Methods of Calculation
The federal income tax on supplemental wages can be calculated in one of two ways depending on how the wages are paid.
When supplemental wages are paid in the same paycheck as regular pay, the income tax is calculated the same as regular pay. That's a good thing. But if supplemental wages are paid separately, they can be taxed at the IRS flat supplemental rate, and this rate is 22 percent as of 2018.
You can check IRS Notice 1036 for more information on current supplemental withholding and supplemental withholding rates, but contrast that 22 percent to the 2018 tax brackets. Regular income is not taxed at 22 percent until a single taxpayer earns $38,701. It's taxed at only 12 percent until this threshold, so it's possible that an employee who earns $38,700 could end up paying a rate on supplemental wages that's almost twice as high.
A Closer Look at the Rules
The IRS specifies that supplemental withholding can be used if the employer has withheld income taxes from regular wages and if the supplemental wages are not paid at the same time as the regular wages. Supplemental wage withholding can also come into play if the supplemental wages are stated separately on the employer's payroll records.
If these conditions are met, the employer has the option of which calculation method to use. He can withhold at either the regular employee-designated rate or the at supplemental rate.
Additionally, expense reimbursements can sometimes be counted as supplemental wages subject to these higher rates. This would be the case if you were entitled to receive reimbursement from your employer for some business-related expense that would have been tax-deductible to you if you itemized your deductions and had not been reimbursed. If you provide a receipt for the expense to your employer and the reimbursement was in excess of what you actually spent, the difference represents supplemental wages.
And for those rare individuals who might earn more than $1 million in supplemental wages, neither of these calculations methods apply. Your employer must withhold at the highest possible federal tax rate, which is 37 percent in 2018, down a little from the 39.6 percent rate in 2017 thanks to the Tax Cuts and Jobs Act which was signed into law in December 2017.
Vacation pay is usually paid along with regular pay. In this case, it should be taxed at the regular withholding rate as determined by the employee's Form W-4. But a bonus or severance pay is usually paid separately so it can be taxed at the supplemental rate.
As a reminder, employees must submit W-4 forms to their employers so employers can determine the amount of withholding of federal income tax from that employee's pay. If your state has an income tax, a state W-4 should also be completed by each employee. Both forms should be completed at hire. Both employer and employees should keep in mind that an employee can change his federal W-4 at any time.