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 the person's regular wages. It may be tempting to lump all wages together, paying and withholding federal income taxes at the same rate as normal pay, but that's not the way these particular wages work.
Supplemental wages can be taxed differently than regular wages, and this can result in some taxpayers paying more in increased income tax withholding.
What Types of Wages Are Supplemental?
Supplemental wages include:
- Overtime pay (if paid separately from regular wages).
- Payments for accumulated sick leave.
- Severance pay.
- Reported tips (if paid separately from regular wages).
- Awards, prizes, and bonuses.
- Back pay.
- Retroactive pay increases.
- Payments for nondeductible moving expenses.
Other payments subject to the supplemental wage rules include taxable fringe benefits and expense allowances paid under a non-accountable plan (more on this below).
- The key to determining if a payment to an employee is subject to supplemental wage withholding rules is whether the payment is separate from regular wages.
- For example, if you give an end-of-year bonus or a severance payment in a separate check, you must follow supplemental pay withholding rules.
- The current supplemental pay withholding rate is a flat 22% for up to $1 million for the year.
Two Ways to Calculate Withholding
The federal income tax withholding on supplemental wages can be calculated in one of two ways depending on how the wages are paid.
For Employees Making Less Than $1 Million a Year
These examples apply to withholding on supplemental wage payments of less than $1 million to any one employee during a year.
First, decide whether the supplemental income will be specified on the employee's paycheck. If you don't specify the amount of each type of pay on the paycheck, withhold federal income tax as if the total were a single payment for that payroll period. If you identify supplemental wages separately and specify the amount for each type of pay, one of two situations applies:
The most common case is to withhold income tax on the supplemental wages from an employee's regular wages, and there are two methods:
- Withhold the supplemental wages at a flat 22% (through 2025)
- Add the supplemental wages to the employee's regular wages paid at the same time (The IRS rules on this are complicated, so be sure to check them out on IRS Publication 15.)
If you didn't withhold income tax from the employee's regular wages in the current or immediately preceding calendar year, use method 2 above. This would be the case if the employee's allowances claimed on Form W-4 were greater than the wages or the employee claimed an exemption from withholding.
|How to Pay Tax on Supplemental Wage Payments (Employees under $1 million)|
|If you withhold income tax from employee's pay||Withhold at regular rate||Withhold at 22%|
|You don't specify supplemental payments||x|
|You specify supplemental payments||x*||x|
|If you don't withhold income tax from employee's regular wages||x*|
|*Check IRS Publication 15 for details on how to pay|
For Employees Making More Than $1 Million a Year
For employees who receive more than $1 million in supplemental wages during the calendar year, you must withhold the excess over $1 million at a higher rate of 37% (or the highest rate of income tax for the year). For example, if an employee's supplemental wages are $1.5 million for the year, you would withhold $1 million at 22% and the excess $500,000 at 37%.
No matter how you pay these wages, make sure you:
- Withhold FICA taxes on each employee paycheck, including separate checks for supplemental wage payments.
- Include supplemental wages in your federal unemployment tax liability calculations.
Common Examples of Supplemental Wages
Vacation pay is subject to withholding as if it were a regular wage payment. If it is paid in addition to regular wages and separately for the vacation period, treat it as a separate supplemental wage payment and follow the rules above. If the vacation pay is for a time longer than your usual payroll period, spread it over the pay periods for which you pay it.
Employers often pay bonuses at the end of a year in a separate paycheck. Here's how that bonus might be paid:
Assume an employee receives $1,000 as a bonus and the most recent gross pay amount was $1,000. The process for determining income tax on this bonus would be:
- Add the bonus amount to the wages from the most recent pay period ($1,000 + $1,000 = $2,000).
- Determine the withholding amount on the combined amount (Let's say it's $150 based on the withholding tables in IRS Publication 15-T.)
- Subtract the amount withheld from the regular wages for that payday, ($70)
- And withhold $80 ($150 - $70) from the bonus paycheck.
- Don't forget you must also withhold FICA tax on that check.
If an employee receives regular wages and reports tips, figure in the tips as supplemental wages for income tax withholding.
- If you haven't withheld income tax from regular wages, add the tips and withhold income tax on the total.
- If you withheld income tax from the employee's regular wages, you can either pay as regular wages or at the 22% rate.
Payments to Employees Under a Nonaccountable Plan
If you make payments to an employee for travel and other business expenses and you don't have an accountable plan, those payments are treated as supplemental income and the employee must pay income taxes, Social Security and Medicare tax, and federal unemployment tax on this income.
In an accountable plan, there are a few guidelines:
- The expenses are clearly business-related.
- The employee must adequately account to you for these expenses by giving you provide you with detailed information for tie, date, place, amount, and business purpose.
- The employee must return excess reimbursement.
Consult a Tax Professional
Paying supplemental wages can be complicated, and incorrectly applying payroll taxes can have tax consequences for your employees and your business. Check with a payroll tax professional or get a payroll service to handle employee pay calculations.