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 pay, payments for nondeductible moving expenses, awards and prizes, back pay and retroactive pay increases, sick pay, severance pay, taxable fringe benefits, tips, and commissions. Other less common types of employee payments may be included in this list.
Supplemental wages can be taxed differently than regular wages, and this can result in some taxpayers paying more in income tax and FICA taxes (Social Security and Medicare).
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. These rules apply to withholding on supplemental wage payments of less than $1 million to any one employee during a year.
Paid in the same paycheck. When supplemental wages are paid in the same paycheck as regular pay, the income tax is calculated the same as regular pay.
Paid separately. If the supplemental wages are paid separately, you can withhold a flat 22%. No other percentage is allowed.
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 is almost twice as high as pay on regular wages.
Don't forget to calculate and withhold FICA taxes on each paycheck, including checks for supplemental wage payments.
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.
An Example - Vacation Pay
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.
Bonuses as Supplemental Wages
Bonuses may be paid in a separate paycheck, sometimes at the end of a year. Here's how that bonus might be paid: Assume the employee receives $1000 as a bonus and her most recent gross pay amount was $1000. The process for determining income tax on this bonus would be:
- Add the bonus amount to the wages from the most recent pay period ($1000 + $1000 = $2000).
- Determine the withholding amount on the combined amount (Let's say it's $150.)
- Subtract the amount withhheld from the most recent paycheck, ($70)
- And withhold $80($150 - $70) from the bonus paycheck.
- Don't forget you must also withhold FICA tax on that check.
Tips as Supplemental Wages
As an employer, you must collect information on employee tips and withhold income tax on tips received by employees. In most cases with an employee who works regularly for you, you calculate income tax withholding as if the tips were supplemental wages, as described above. in other words, include the tip income in your calculations for income taxes and FICA taxes.