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Payroll in Practice: 11.28.2022

Nov. 28, 2022, 1:50 PM

Question: Is the gross amount or taxable amount of supplemental pay used to determine when an employee’s cumulative supplemental wage payments during the calendar year reach the $1 million threshold where the mandatory flat rate must be used?

Answer: In general, the taxable portion of supplemental wages is counted toward the $1 million threshold. The mandatory flat withholding rate, currently 37%, is applied to an employee’s gross taxable supplemental wages exceeding $1 million during a calendar year.

Some payments might not be taxable or taxable as supplemental pay. For example, tips and overtime pay are defined as supplemental wages. However, an employer may elect to treat tips or overtime pay as regular pay. Some taxable payments or benefits are not subject to income tax withholding, such as excess group term life insurance and normally would not count toward the threshold. However, the employer may elect to treat the taxable portion of group-term life insurance as supplemental pay for purposes of determining when the $1 million threshold is reached.

Payments or benefits that are exempt from income tax are neither regular nor supplemental pay. For example, the value of employer-provided health care benefits and employee salary reduction 401(k) plan deferrals are not taxable wages for income tax purposes and are not subject to withholding for that reason.

The threshold requires employers to identify and track supplemental pay. Regulation 26 C.F.R. 31.3402(g)-1 defines supplemental pay and lists examples of specific types of remuneration used to determining an employee’s cumulative supplemental pay.

Generally, any remuneration that is not regular wages is supplemental wages. Regular wages are amounts paid at a regular hourly, daily, or similar periodic rate for the current payroll period or at a predetermined fixed determinable amount, such as a salary, for the current payroll period. Regular wages do not include overtime pay.

Supplemental wages are generally payments that relate to more than one payroll period or are payments identified as supplemental wages even if they apply to the current payroll period. The regulation lists examples of items that are supplemental pay, such as noncash fringe benefits, severance pay, bonuses, overtime pay, and sick pay.

Salary reduction deferral amounts excludable from income tax are excluded from the $1 million threshold if they are attributable to supplemental wages, such as bonuses or commissions. The employer must allocate a salary reduction deferral to gross regular wages or gross supplemental wages based on the type of compensation being deferred.

For example, Company A’s plan specifies deferrals of 5% for salary and commissions. An employee is paid $5,000 in salary, with $250 deferred, as regular pay, and $10,000 in commissions, with $500 deferred, as supplemental pay.

The $9,500 in commissions that is not deferred is included when determining cumulative supplemental wages for mandatory flat-rate purposes. The $500 deferral does not count toward the threshold.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, N.C., and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.

To contact the editor on this story: William Dunn at wdunn@bloombergindustry.com