The last quarter of the year is when many companies issue “year end” or “holiday” bonuses to their employees. Regardless of how they are presented, these wages are separate from the normal payroll wages issued throughout the year and are subject to specific taxation regulations.
What are Supplemental Wages?
According to IRS Publication 15, Employer’s Tax Guide, “Supplemental wages are compensation paid in addition to an employee’s 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 are Supplemental Wages Taxed?
There are two methods of taxation that have been approved by the IRS for withholding on supplemental wages: the aggregate method and the supplemental rate method.
- With the aggregate method, the additional wages are combined with the employee’s regular wages, and taxes are calculated on the entire amount using the employee’s wage rate based on their tax status and number of exemptions. The employee’s Form W-4 dictates the rate of withholding the employer must use for this method.
- With the supplemental rate method, the additional wages are taxed using the flat federal tax rate of 25% (if under $1,000,000) and a rate specified by the employee’s withholding state. Wisconsin uses a tiered schedule.
Do not withhold a flat dollar amount or zero unless the withholding calculates at zero. If the employee requests to have the aggregate method used and wants to have additional withholding taken off or change their tax status or exemptions, they must complete a new Form W-4 before the wages are paid. The employee will then need to complete another Form W-4 to change the withholdings back after the supplemental wages have been paid so that their normal payroll status and exemptions are returned to normal.
Note: employers have up to 30 days to implement any change to an employee’s tax status upon receiving a new Form W-4. The employer should be consistent with how they handle these changes throughout their employee base and not discriminate for any specific group of employees.
If you have any questions in regards to supplemental wages and taxation, please contact a member of our payroll services team.
Jenny Roszak, CPP, is an associate accountant and the payroll services coordinator for our Sheboygan office, where she specializes in providing accounting and payroll services to our small business clients. She has more than 10 years of experience working with a variety of clients and software applications.