Withhold Taxes on Supplemental Wages

The Ins and Outs of Supplemental Wages

How Taxes Are Withheld from Supplemental Wages

Part 1 of this series explored the difference between supplemental wages and regular wages. Now, in Part 2 of the series, we will cover exactly how to calculate the taxes on supplemental wages.

IRS Publication 15 describes several methods of calculating the federal income tax withholding on supplemental wages. These methods could be summarized as follows:

Add the entire amount to the employee's regular wages, and withhold the federal income tax based on the employee's Form W-4.
Withhold a flat 22% of the supplemental wages.
Perform a complex calculation to calculate the tax withholding on the supplemental wages alone.

The first method is relatively simple, and if the employee receives regular wages and income taxes are usually withheld, this method can be used whether or not the supplemental wages are identified separately on the employee's pay stub. Most overtime pay, certain taxable fringe benefits (such as group term life insurance), and smaller bonuses usually don't result in an employee's wages being projected into a higher tax bracket, so this is the most common method of taxing supplemental wages.

The second method is the simplest. For instance, a $2,000 bonus would have $440 deducted in federal taxes. (The IRS does not allow any other percentage to be used.) However, this method can be used only if the employer has withheld income taxes from the “employee's regular wages in the current or immediately preceding calendar year.”

The third method requires a more complex calculation, and it is used only if the supplemental wages are paid separately from regular wages or if the employer has “not withheld income tax from the employee's regular wages in the current or immediately preceding calendar year.”

The third method requires the following steps:

Identify the employee's regular wages. This could be the employee's current regular wages, or the regular wages paid for the previous payroll period if there are no current wages.
Determine the federal income tax withholding from the regular wages. This is done by calculating the tax withholding on the current regular wages or by checking payroll records to determine what was withheld from the regular wages paid in the previous payroll period.
Add the supplemental wages to the regular wages and figure the tax withholding based on the employee's Form W-4.
Subtract the tax withheld from regular wages from the total tax, and withhold the difference from the employee's supplemental wages.

There is one major exception to the above rules. If an employee receives more than $1 million of supplemental wages during the calendar year, then any supplemental wages paid in excess of $1 million are “subject to withholding at the rate of 37% (or the highest rate of income tax for the year).”

In addition to federal income taxes on supplemental wages, many states also have rules for withholding state income taxes on supplemental wages, so each employer is obligated to check state rules as well.

Why Some Income Payments May Be Delayed

Every employee is entitled to receive payment for all compensation earned. However, as noted in the above article, some compensation is treated as supplemental wages, so it may not be paid at the same time as regular wages, and taxes may be withheld differently. But regardless of whether the income is regular wages or supplemental wages, it is all reportable income at the end of the year.

We hope this guide makes it easier to differentiate between supplemental and regular wage payments. Go forth, and pay your team with confidence!