Supplemental wages are wage payments to an employee that are not regular wages. They include, but are not limited to, bonuses, commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, retroactive pay increases, and payments for nondeductible moving expenses. Other payments subject to the supplemental wage rules include taxable fringe benefits and expense allowances paid under a nonaccountable plan. How you withhold on supplemental wages depends on whether the supplemental payment is identified as a separate payment from regular wages.
If you pay supplemental wages separately (or combine them in a single payment and specify the amount of each), the federal income tax withholding method depends partly on whether you withhold income tax from your employee's regular wages. There are two methods: (1) Withhold at a flat 25% (no other percentage permitted); or (2) If the supplemental wages are paid concurrently with regular wages, add the supplemental wages to the concurrently paid regular wages and calculate the federal withholding tax using the aggregate method.
Special rules apply to supplemental wages paid to any one employee during the calendar year exceeding $1 million. If a supplemental wage payment, together with other supplemental wage payments made to the employee during the calendar year, exceeds $1 million, the excess is subject to withholding at 39.6%.
Jurisdiction Impact. States may have their own supplemental tax laws that may be broader and cover additional payment types. Employers should be familiar with how applicable state laws impact employee supplemental pay and check with their tax professional to fully assess how these laws may affect their employees.
For compliance purposes and as a best practice it is recommended employers always follow the Internal Revenue Service (IRS) withholding rules as clearly stated in the IRS Publication 15 (Circular E), Employer’s Tax Guide, Supplemental Wages. Employers can face penalties for not following the IRS withholding regulations.
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