Supplemental wages are income an employee earns in addition to their regular wages. Supplemental wages aren’t like basic wages, which can be earned as hourly income. However, employers can withhold taxes from this additional income.
Employers may give supplemental pay as rewards to motivate their employees. However, certain payments that fall under this category need to be taxed as per the law.
The following payments don’t qualify as supplemental pay:
Paid time off.
Vacation pay and paid time off are included in every employee’s regular income, which is why they don’t fall under the supplemental pay category. Stipends also aren’t considered in this category, as employees aren’t paid for things like non-deductible moving expenses, child care, or traveling.
Who is Responsible for Reporting These Wages?
Employers are responsible for tracking and reporting all the supplemental wages each employee earns. It’s also up to them to decide whether to disburse the additional pay separately or combine it with the basic wages. They should also keep a record of how much supplemental income an employee earns in a specific tax year.
How are these Wages Taxed?
Since supplemental wages aren’t the same as regular wages, federal income tax withholding on these can be different than on regular pay. Even with a Form W-4, an employee will still be subject to additional withholding for the supplemental income.
Generally, there are two ways to calculate the withholding taxes on the supplemental income of individual employees: those making less than $1 million a year and those making more than $1 million a year. Note that all extra income is subject to FICA and federal unemployment taxes.
1. Supplemental Income Less Than or Equal to $1 Million
Employees making $1 million or less a year in supplemental income may face two circumstances with their tax withholdings. In this case, they should decide how they want to account for their earnings in their statements.
If they don’t specify every supplemental wage they receive and decide to count them with their regular wages, the federal tax will be withheld as if it’s all one payment.
If supplemental pay of individual employees is separately reported and identified from their regular wages, either of the two methods will apply according to IRS Publication 15:
(a) Withhold a flat 22 percent tax rate only if the employer has already withheld tax from regular income for the running tax year. No other percentage is allowed unless stated otherwise in a given tax year.
(b) Combine supplemental income with the employee’s regular income and withhold federal income tax from the total using the employee’s W-4 form. It’s only allowed if the employer pays the supplemental income simultaneously with the regular wages.
2. Supplemental Income of More Than $1 Million
If any employee earns more than $1 million in supplemental income in the running tax year, that money will be taxed up to 37 percent, or the highest income tax rate in that year. Paying these taxes is mandatory, even if an employee has filled out a Form W-4.
How Can an Employer Calculate These Wages?
There are three methods employers can follow when calculating wages and withholding taxes: the percentage method, the aggregate method, and the method to follow for employees earning more than $1 million a year in supplemental pay. All these methods are shown below with examples.
1. Percentage Method
This method is one of the most straightforward to follow, as it only involves withholding 22 percent tax from the supplemental income. It will only apply if the employee earns $1 million or less in this income category in a tax year.
Let’s say an employee earns $900 in bonuses and tips. The employer will then be withholding the following amount in taxes:
2. Aggregate Method
Calculations using this method depend on whether an employer pays the supplemental income simultaneously with the regular wages or separately. These will only apply to those who earn $1 million or less in supplemental pay in a year. Let’s look at both types of calculations.
(a) Concurrent Payment
Withholding taxes with concurrent payments is easier, as all the calculations will be done at once. Employers can find the tax bracket of individual employees using the income tax withholding tables discussed in IRS Publication 15, the W-4 forms, and the filing status.
(b) Separate Payment
With the separate payment method, withholding taxes involves a few more steps and may seem more complicated.
Add the supplemental income with regular wages.
Figure out the tax withholding on this amount from the tax withholding tables in IRS Publication 15.
Determine the tax withholding on only the regular payments from the withholding table.
Subtract the amount in step 3 from the amount in step 2.
The amount found in step 4 is the tax to be withheld on the supplemental income of an employee.
3. Method for More Than $1 Million in Supplemental Earnings
Another method to follow, but only if an employee earns more than $1 million of supplemental income in a calendar year, is to withhold 37 percent in taxes on the amount earned in excess after $1 million.
Let’s say an employee earns $1,100,000 in a particular year on bonuses, awards, tips, overtime, accumulated sick leave, etc. The employer will withhold taxes on this income in the following way:
($1,100,000-$1,000,000)= $100,000, which is the excess after $1 million.
37 percent tax will be withheld on this excess. Therefore,