IRS Rules for Supplemental Wages Withholding

Supplemental wages can sometimes be taxed at a flat rate

Accountant or banker making calculations
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Supplemental wages are paid to an employee in addition to the person's regular wages. It may be tempting to lump all wages together and pay them at the same rate, but that's not the way these wages work.

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).

What Types of Wages are Supplemental?

Supplemental wages can include

Other payments subject to the supplemental wage rules include taxable fringe benefits and expense allowances paid under a nonaccountable plan (more on this below). 

The key to whether a payment to an employee is subject to supplemental wage rules depends on whether the payment is a separate payment from regular wages.

Two examples of the difference are end-of-year bonuses or a severance payment, given separately from the employee's normal paycheck.

The current supplemental pay rate is a flat 22%.

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.

If you withhold taxes. The most common case if one in which you withhold federal income tax from an employee's paycheck. First, look at whether the supplemental income is specified on the employee's paycheck:

  • If you don't specify the amount of each type of pay, withhold federal income tax as if the total were a single payment for that payroll period.
  • If you specify the amount for each), one of two situations applies, depending on whether you withhold federal income tax from the employee's regular wages.in this case, you can:
    • a. withhold the supplemental wages at a flat 22% or
    • b. 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 b above. This would be the case if the employee's allowances claimed on Form W-4 were greater than the wages.

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% rate
   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 who receiver more than $1 million of supplemental wages during the calendar year, you must withhold the excess at a higher rate of 37%, or the highest wage rate 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%.

ALL supplemental wages are subject to FICA taxes (Social Security/Medicare tax) and federal unemployment tax. No matter how you pay these wages, make sure you:

  • Withhold FICA taxes on each employee paycheck, including checks for supplemental wage payments, and
  • Include these wages in your federal unemployment tax liability.

 

Common Examples of Supplemental Wages

Vacation Pay as Supplemental Wages

Vacation pay is subject to withholding as if it were a regular wage payment. If it is in addition to regular wages for the vacation period, treat it as a supplemental wage payment. 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. 

Bonuses as Supplemental Wages

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 $1000 as a bonus and the most recent gross pay amount was $1000. The process for determining income tax on this bonus would be:

  1. Add the bonus amount to the wages from the most recent pay period ($1000 + $1000 = $2000).
  2. Determine the withholding amount on the combined amount (Let's say it's $150, from the withholding tables.)
  3. Subtract the amount withheld from the most recent paycheck, ($70)
  4. And withhold $80($150 - $70) from the bonus paycheck.
  5. Don't forget you must also withhold FICA tax on that check.

Tips as Supplemental Wages

If an employee receives regular wages and reports tips, figure 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.

An accountable plan is one in which:

  • 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, and
  • the employee must return excess reimbursements. 

The information in this article is intended to be general, not specific tax advice. 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 paychecks.

Article Sources

  1. IRS. "Publication 15 (Circular E, Employer's Tax Guide." Supplemental Wages. Page 19. Accessed Dec. 17, 2019.

  2. IRS. "Publication 15 (Circular E, Employer's Tax Guide." Vacation pay as supplemental wages. Page 20. Accessed Dec. 17, 2019.

  3. IRS. "Publication 15 (Circular E, Employer's Tax Guide."Bonuses - Example 2. Page 19. Accessed Dec. 17, 2019.

  4. IRS. "Publication 15 (Circular E, Employer's Tax Guide."Tips treated as supplemental wages. Page 20. Accessed Dec. 17, 2019

  5. IRS. "Publication 15 (Circular E, Employer's Tax Guide." Nonaccountable plan. Page 15. Accessed Dec. 17, 2019.