Supplemental wages include, but are not limited to: bonuses, commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, reported tips, retroactive pay increases, and payments for nondeductible moving expenses. As you can probably gather, supplemental wages more or less function as a catchall for income paid by your employer or originating from your job that is not paid with the same periodic regularity as normal wages or a salary.
The greatest of type of supplemental wage is definitely the bonus, partially because bonuses are so highly coveted due to their exciting, windfall-like nature, and partially because there seems to be the greatest misconception within the general public around withholding taxes from bonus income earned by an employee. With regard to this misconception, the short answer is that all supplemental wages, including bonuses, are subject to the same graduated tax rates as all other earned income, but they are possibly withheld differently from normal wages or salary.
The first determination that must be made in terms of tax withholding is whether the employee makes more or less than $1 million in supplemental wages in a given year. Notice this analysis centers on the total amount of supplemental wages paid to the employee during the tax year, and not his or her total income. If it’s the case that total supplemental wages are over $1 million, then the withholding on all supplemental wages over the $1 million mark is the highest marginal rate for that tax year.
For example, if an employee had a regular annual salary of $750,000, but $1,250,000 in bonuses paid during tax year 2020 (an enviable position, to be sure), then the employer should withhold $250,000 of the bonus, all of which would be considered supplemental wages, at the highest marginal rate, which for 2020 is 37%. Therefore, the withholding for the $250,000 above the $1 million threshold would be $250,000 X .37 = $92,500. Just to note, the rest of the employee’s income, being the $750,000 regular salary and the other $1 million in bonuses, would also be subject to withholding, as we’ll discuss specifically, later in this article.
For supplemental wags below the $1 million threshold, there are a couple different methods for withholding. The first method is used where supplemental wages are not differentiated from normal wages paid. So this would occur, for example, if a $1,000 bonus was combined with $3,000 of normal wages in a given pay period, with the employee being simply cut a check for $4,000 without any evidence showing he was paid a bonus. In other words, his paycheck for that period was just $1,000 more than it otherwise would have been. In this example, the employer would withhold from wages as it normally would, presumably based on the employee’s Form W-4, even though there is a $1,000 additional supplemental wage component for the pay period used in this example.
The second method for withholding supplemental wages below $1 million involves a scenario where there is a differentiation between the amount of regular wages or salary paid and the amount of supplemental wages. Additionally, it also matters whether income taxes were withheld from that employee’s wages or salary during the current or previous tax years. Under these circumstances of differentiation, one of two sub-methods applies, and the employer gets to choose which it implements. The first sub-method is a flat 22% withholding on the supplemental wages paid under $1 million. So in the previous example, where the total bonus was $1,250,000, withhold the first $1 million at 22%, or $220,000.
The other sub-method of withholding, when supplemental wages are below $1 million and differentiated, depends on whether supplemental wages are lumped together with regular wages or salary. If it’s the case they’re lumped together, then withhold according to the standard Form W-4 withholding for that employee, taking into consideration taxes already withheld on amounts paid. Even if no wages or salary are paid for that period, look back to the previous payroll period and aggregate the wages or salary paid at that time with the supplemental wages paid in the current period, and withhold from that lump sum as if it was all normal wages or salary paid, taking into consideration amounts already withheld for income taxes. Note that if there was no income taxes withheld from the regular wages or salary of an employee that currently is receiving supplemental wages under $1 million, which is a very unlikely scenario, then withhold from the supplemental wages using this latter sub-method.
Some final notes here at the end are necessary. First, because they constitute ordinary earned income, all supplemental wages are subject to social security, Medicare, and the Federal Unemployment Tax Act (FUTA) taxes. Next, tips are either considered supplemental wages or can be considered regular wages, and therefore can be withheld either as articulated in this article, or just as they would be normally by the employer, under the auspices of the employee’s Form W-4. Finally, vacation pay, which is an amount paid to an employee for the value of unused vacation days, is considered supplemental wages and should be withheld according to one of the methods described in this article.
If you need help with anything to do with supplemental wages paid to an employee or multiple employees, or if you received supplemental wages as an employee and have questions, don’t hesitate to contact Dino Tax Co today at firstname.lastname@example.org or call (713) 397-4678. The first phone consultation is always free. Also if you enjoy what we do, give us a like on Facebook here.
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