Taxation is never simple, but supplemental wages (payments made in addition to an employee’s ordinary wages) are in a league of their own when it comes to government regulation. They are subject to Social Security and Medicare taxes, separate state-specific withholding practices and state labor department requirements, increasing the complexity of compliance.
Staying compliant is complex, but it’s never been so important, due to increased Department of Labor crackdowns on wage and hour violations under the Fair Labor Standards Act. With audits and investigations becoming more and more common thanks to increased IRS funding, the consequences of mishandling supplemental wages are more serious than ever.
The good news is, we’ve prepared this guide with everything employers need to know.
Quick facts about supplemental wages
Supplemental wages include, but are not limited to:
- Accumulated sick leave
- Bonuses
- Commissions
- Tips
- Severance pay
- Overtime pay
- The value of taxable fringe benefits
- Awards
- Prizes
- Back pay
- Retroactive pay
- Nondeductible moving expenses
Supplemental Wages vs. Regular Wages
It is important to understand the difference between supplemental and regular wages because the two types are subject to different federal wage laws and different withholding practices. For example, whereas regular wages must be paid within seven days of the end of the determined pay period, supplemental wages do not, and therefore the two can be paid at different times.
Withholding Procedures for Supplemental Wages
Regular wages are usually withheld based on marital status and numbers of withholding allowances, but supplemental wages are not. To withhold taxes on supplemental wages, an employer can:
- Add together the entirety of the employee’s wages (supplemental and regular) and withhold taxes on the entire amount.
- Identify supplemental wages separately and withhold a flat tax rate of 25%. The IRS does not allow any other rate.
- Or, perform a complicated calculation to figure the tax withholding on the supplemental wages and regular wages separately.
And there is more: if the supplemental wages do not exceed one million dollars, employers can choose to combine and tax all the wages or they can use the flat 25% rate. But if the supplemental wages do exceed one million dollars, the employer must withhold a 37% tax on the excess amount after one million dollars.
Further, there are exceptions on how to treat vacation and tips. Vacation pay is treated as a supplemental wage if the pay is more than the regular wages that would be paid during that time. Tips are treated as supplemental wages if the employee receives wages and tips. If the employer does not withhold tax from the regular wages, tips are added to the regular wages and the entire amount is taxed.
Between the federal regulations described here and the taxation rules in each U.S. state, supplemental wages can make your head spin. Now more than ever, wage and hour missteps are not ones you can afford to make. It’s a smart choice to partner with an expert to protect your business from costly penalties.
How Paycor Can Help
We’re proud to keep more than 30,000 organizations informed and compliant with federal and state laws and regulations. Since 1990, Paycor has maintained a core expertise in payroll and compliance. We established our compliance expertise in the Cincinnati tri-state area, one of the most complex tax jurisdictions in the country. Contact our team today to learn how we can help you manage payroll and tax complexities across your business.
Source: U.S. Department of Labor
