When we say supplemental wages, this is a term that is used to refer to any payment made to an employee that is separate from their regular wages. Gaining an understanding of supplemental wages is important because they are taxed differently than how regular wages are taxed. Employers who give supplemental wages are required to withhold taxes from these payments.
What are common examples of supplemental wages?
The following is a list of some common examples of supplemental wages as per the Internal Revenue Service (IRS). Supplemental wages include but are not limited to:
Accumulated sick leave pay
Retroactive pay increases
Payments made for nondeductible moving expenses
Taxable fringe benefits
Expense allowances paid under a nonaccountable plan
According to the IRS, employers can choose to treat overtime pay and tips as part of regular wages.
In contrast, examples of payments that are not supplemental wages are stipends, paid time off (PTO), and vacation pay. In identifying supplemental wages, keep in mind that for as long as payment is not part of an employee’s regular wages, it is supplemental. For example, PTO and vacation pay are considered supplemental wages only if they are unused and are paid out to employees in the form of a lump sum.
It is the responsibility of the employers to monitor and report supplemental wages that are paid to employees. How they withhold taxes on supplemental wages would highly depend on the amount of supplemental wages paid during a tax year and if the supplemental wages were combined with regular wages or were identified as separate from regular wages.
How are supplemental wages taxed?
The process of withholding taxes from supplemental wages depends on the amount received by the employee.
For employees who receive more than $1 million of supplemental wages during the calendar year. In this case, the money that is over the one million dollar threshold is subject to 37% withholding. This is the highest rate of income tax for the year and this is not affected by the employee’s Form W-4 claiming exemption from federal income tax withholding.
For employees who receive $1 million or less of supplemental wages during the calendar year. Before making the tax calculation, employers must first decide if they will specify supplemental wages on the employee’s paycheck.
If you choose to combine supplemental wages with regular wages but you do not indicate the amount of each one, you need to withhold federal income tax in such a way that the total amount was a single payment during a regular pay period.
If you choose to identify supplemental wages separately from regular wages, you can do one of the following:
Withhold supplemental wages at a flat rate of 22% if you have withheld income tax from the employee’s regular wages in the current or prior tax year.
Add the supplemental wages with the employee’s regular wages that were paid simultaneously or at the same time. Withhold federal income tax from this total amount using the employee’s Form W-4.
An important note to employers, the rules on supplemental wages withholding can be complex. To be sure, check IRS Publication 15 and go to the section on Supplemental Wages.
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