The Myriad Ways to Withhold Supplemental Wages

The methods that employers use to withhold federal income tax on supplemental wages depend on several factors and can have different effects on employees’ personal income taxes, a payroll expert said May 10.

Supplemental wages include any payments that are not regular wages, such as bonuses, commissions, and payments for accumulated leave, said Rosemarie Fraumeni, Payroll Manager for Lantheus Medical Imaging, Inc. Fringe benefits and certain expense allowances are also examples of supplemental wages.

“If it isn’t regular wages, or what you always pay your employee, then it’s supplemental wages,” Fraumeni said at PayrollOrg’s 42nd Payroll Congress in Nashville. “It’s as simple as that. If it isn’t their regular salary or hours being multiplied by their hourly rate, then it’s supplemental wages.”

However, employers may choose to treat overtime pay and tips as regular wages instead of supplemental wages, she added.

For federal income tax purposes, there are four different types of withholding methods, she said. The method required depends on whether the supplemental wages are combined with regular wages and whether federal income tax was withheld from the employee’s wages in the current or immediately preceding calendar year.

“So, who gets to decide what method we are going to use? It’s not the employee; it’s the employer,” Fraumeni said. “It’s our responsibility to make sure that we are withholding federal income taxes correctly.”

Use of the mandatory flat rate method depends on whether an employee’s year-to-date wages exceed $1 million, she added. The employer must use the mandatory flat rate method even if the employee claims exempt from federal income tax on Form W-4, Employee’s Withholding Certificate, she said. Under the mandatory flat rate method, the employer must withhold 37% on the amount exceeding $1 million, regardless of any other factors. For the portion of the supplemental wages under $1 million, the employer must withhold using one of the other three methods.

Unless the mandatory flat rate method applies, employers may use the aggregate method for any other type of supplemental pay, she said. Further, the aggregate method is required if federal income tax was not withheld in the current or immediately preceding calendar year and the supplemental wages and regular wages are separately identified.

If supplemental wages are paid at the same time as regular wages, employers should add the amounts together and withhold as if the total was a single payment, she said. Otherwise, employers must add the supplemental wages to either the regular wages paid for the preceding payroll period or the regular wages to be paid for the current payroll period, she added. Employers must then calculate the income tax withholding as if the total were a single payment, subtract the tax already withheld or to be withheld from regular wages, and then withhold the remaining tax from the supplemental wages.

Another method allows employers to treat supplemental wages as regular wages if they are paid together and the amount of each is not specified, she said. An employer would simply calculate federal income tax withholding on the total using the employee’s Form W-4.

“If you do this for some of your lower-paid folks, this will bump them into a higher tax bracket,” Fraumeni said. “They will not get as much of the supplemental wages when you do it this way. For some of your higher-paid employees, it’s not so bad. It will get them into the right tax category, and they will be very happy that the extra taxes are coming out.”

The last method, the optional flat rate method, only applies if supplemental wages and regular wages are separately identified and federal income tax was withheld from the employee’s regular wages in the current or immediately preceding calendar year, she said. Employers using this method withhold 22% on just the supplemental wages.

She warned that the optional flat rate method can result in certain highly paid employees, such as commissioned salespeople, owing additional taxes at the end of the year. These employees might want to consider updating their Form W-4 to have additional tax withheld, Fraumeni said.