Payroll Costs for Supplemental Payments to Employees
Following enactment of the tax reform bill, there were many companies reporting their payment of bonuses of $1,000 or more to workers. These non-regular wages are considered supplemental wages. They are taxable compensation to employees and subject to employment taxes just like regular wages. This means you must withhold income taxes and the employee's share of FICA and pay the employer share of FICA and unemployment taxes. But how you figure withholding for these supplemental payments is another story.
Types of supplemental payments
These payments can result from a wide array of compensation, including:
- Accumulated sick pay
- Back pay
- Overtime pay
- Reimbursements under a nonaccountable plan
- Retroactive pay increases
- Sick leave
- Taxable fringe benefits
Withholding on supplemental payments
When an employee receives supplemental wages, an employer has a choice in how to figure withholding on these payments, depending on how the supplemental wages are reported to the employee, as well as the amount of the supplemental wages for the year:
Combined regular and supplemental wages. When supplemental wages are lumped in with regular wages, withholding is figured according to the employee's withholding allowances indicated on their Form W-4.
Separately paid supplemental wages. When these supplemental amounts are identified separately from regular wages, the employer (not the employee) has a choice on how to withhold:
- Withhold a flat 22 percent of the supplemental payments (referred to as the "optional method"). You cannot use any other percentage.
- Add the supplemental payments to the regular wages (assuming there are concurrent regular wages) and withhold as you would for those regular wages (referred to as the "aggregate method"). See "Combined regular and supplemental wages" section above.
The IRS gives these examples to illustrate the two options:
Example for flat 22 percent withholding: An employee who is single and claiming one withholding allowance receives pay of $2,000 and a bonus of $1,000 that's separately identified (supplemental wages). The employer withholds $220 ($1,000 x 22%) from the supplemental payment and regular withholding from their normal wages of $2,000.
Example for combining regular and supplemental wages: An employee who is single and claiming one withholding allowance receives a salary of $1,000 and a bonus of $2,000 that's separately identified. The employer opts to add them together and figure withholding on the total (the correct withholding on $3,000 for this employee is $264).
The IRS has guidance on some special situations, including signing bonuses, commissions paid with no regular wages, and other situations that employers may encounter. This guidance is in Rev. Rul. 2008-29.
Special rule for supplemental payments over $1 million. If the total amount of such payments to an employee during the year exceeds $1 million, they are subject to a flat withholding rate of 37 percent. This rate applies without regard to what this employee may have indicated for withholding purposes on his or her Form W-4. Total amounts include supplemental payments from all businesses under common control.
When an employee receives supplemental wages and the employer chooses to withhold at a flat 22 percent rate, the employee may be underwithheld for the year. This is so if the employee is in a tax bracket above 22 percent or has income from other sources (such as investments) that are not subject to any withholding. The employee may request additional withholding from an employer to avoid the need to make estimated tax payments or themselves with a big underpayment of tax (and a penalty) when the income tax return for the year is filed.
How to figure withholding on regular and supplemental wages is fixed by the IRS. If you use a payroll provider, they can help you make these calculations.