Federal income tax withholding on supplemental wages
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May 2022
Sally Hilton CPP, director of payroll training for the American Payroll Association explains how to proceed for tax purposes when processing supplemental wages
Although payroll software generally defaults to the optional flat rate of 22% federal income tax (FIT) withholding for supplemental wages, this option isn’t always the appropriate method to use.
As per the United States’ IRS Publication 15 (2022), (Circular E), Employer’s Tax Guide, supplemental wages are payments that aren’t regular wages. The guide can be located here: http://ow.ly/jgfm30sjlMr.
Supplemental wages should be coded as such. The system tracks year to date taxable supplemental wages for each employee. Special rules apply if supplemental taxable wages paid to an employee during a calendar year exceed $1 million. At that point, all supplemental wages must be taxed at 37%. There are no exceptions, even if the employee is claiming exemption on their form W-4. You must use the mandatory flat rate on supplemental wages for the remainder of the year.
Correct methods of withholding
For most employees, the mandatory flat rate won’t apply. Let’s clarify the acceptable methods of withholding for employers with employees with $1 million or less in supplemental wages in a year.
You can always use the aggregate method. Here, you add the supplemental wages with the current, or most recently, paid regular wages. Then you tax the combined amount based on the employee’s form W-4. The following are some examples:
Example 1: An employee was paid a $2,000 taxable salary and a $250 taxable bonus on the same date. The combined taxable wages of $2,250 are used for determining the amount to withhold for FIT based on the employee’s form W-4
Example 2: An employee was paid a $2,000 taxable salary last week and will receive a $250 taxable bonus this week. FIT withholding was calculated on the $2,000 taxable wages last week. Calculate the total withholding on the combined amount of $2,250 based on the regular pay and the employee’s form W-4. Subtract the amount that had been withheld from last week’s regular wages. The difference is the amount to be withheld from the bonus.
The optional flat rate method
If electing to use the optional flat rate method, there are conditions that must be met first. Your payroll system may not determine if the conditions are met. That’s up to you. The current optional flat rate is 22%. While using this method is easy, it’s not appropriate for all employees. It may result in over-withholding for some and under-withholding for others.
Conditions for using the optional flat rate are as follows:
1.) FIT has been withheld from the employee’s regular wages either in the current or previous year. If an employee claims allowances on the pre-2020 form W-4 or claims dependents or credits on the 2020 or later form W-4 that results in no withholding, you cannot use the optional flat rate
2.) the employee isn’t currently claiming exemption from withholding on their form W-4, assuming the employee has $1 million or less of supplemental wages.
If using the optional flat rate method in examples one and two above, $250 x 22% = $55 of FIT withholding. The regular wages of $2,000 would be taxed as per the employee’s form W-4.
It’s the employer’s choice whether to use the optional flat rate. However, it’s important they remember there are conditions that must be met first.
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