Flat Tax Withholding: What It Means for Employers

What it means in practice

What makes withholding "flat". Ordinary federal income tax withholding runs each paycheck through the employee's Form W-4 and the graduated tables in Publication 15-T. A flat rate skips that step and multiplies the payment by one percentage. Publication 15-T says its wage bracket and percentage methods cannot be used when the 37% mandatory flat rate applies or the 22% optional flat rate is used. Employers meet flat rates on supplemental wages, backup withholding, retirement plan distributions, some payments to nonresident aliens, and state supplemental wage rules. Social Security and Medicare are fixed percentages too, but are separate taxes covered under FICA. What counts as a supplemental wage is defined on our supplemental wages page and is not repeated here.

Where the 22% and 37% come from. The Treasury regulation sets the optional rate for supplemental wages paid after December 31, 2004, at 28 percent "or the corresponding rate in effect under section 1(i)(2)" for the year, and sets the mandatory rate at the highest rate under section 1 of the Internal Revenue Code (26 CFR 31.3402(g)-1(a)(2) and (a)(7)(iii)(F)). Publication 15 (2026) states that the rates remain 22% and 37% because P.L. 119-21 permanently extended the individual tax rates enacted in P.L. 115-97. The optional rate has moved with the tax brackets before. The regulation lists 20% for supplemental wages paid from May 1, 1966 through 1993, 28% from 1994 to August 6, 2001, 27.5% for the rest of 2001, 27% from 2002 to May 27, 2003, and 25% through 2004.

When the 22% rate is allowed. Under 26 CFR 31.3402(g)-1(a)(7), an employer may use optional flat rate withholding only if three conditions are met: the mandatory rate does not apply to the payment or portion; the supplemental wages are paid at a different time from regular wages or separately stated on the payroll records; and income tax was withheld from the employee's regular wages in the current or preceding calendar year. The amount is figured without reference to regular wages and without regard to Form W-4 entries other than a claim of exempt status. If the conditions are not met, the employer must use the aggregate procedure in paragraph (a)(6), which adds the supplemental payment to regular wages and uses the Form W-4.

Running the $1 million test. Mandatory flat rate withholding ignores the Form W-4, including an exempt claim, and the employer's withholding method (26 CFR 31.3402(g)-1(a)(2)). All persons treated as a single employer under section 52(a) or (b) count as one employer, and payments by a third party acting as the employer's agent count as paid by the employer. An agent that pays an individual less than $100,000 in total wages in a year may be disregarded, but not if the employer uses five or more agents and a principal effect is to reduce mandatory withholding. Employers may count amounts reported in box 1 of Form W-2 that are not subject to withholding when testing the threshold, and must allocate salary reduction deferrals to the type of pay actually deferred. Only the part of a payment above $1 million must take the mandatory rate, but the employer may apply it to the whole payment.

Interactions with other payroll rules. Publication 15 says the extra amount added to a nonresident alien employee's wages to figure withholding does not apply to a supplemental wage payment when the 37% mandatory rate applies or the 22% optional rate is used. Publication 15-A says sick pay paid by an agent of the employer is treated as supplemental wages, and an agent that does not pay the employee regular wages may choose to withhold at a flat 22% rather than the wage withholding rate. Publication 15 lets employers withhold on taxable fringe benefits at the optional 22% rate instead of adding their value to regular wages. When an employer promises a bonus net of withholding, the flat rates feed into the gross-up calculation; the regulation's Example 4 grosses up the portion above $1 million at the mandatory rate.

Backup withholding: a flat rate for non-wage payments. Section 3406 of the Internal Revenue Code requires a payor to withhold tax equal to the fourth lowest rate under section 1(c) from certain reportable payments. Publication 1281 gives the rate as 24% for payments after December 31, 2017; the statute's notes show earlier rates of 20% and, from 1992, 31%. According to IRS Topic 307 and the Instructions for the Requester of Form W-9, backup withholding applies when the payee fails to furnish a TIN, the IRS notifies the payor that the TIN is incorrect, the IRS notifies the payor of underreported interest or dividends, or the payee fails to certify that it is not subject to backup withholding. Publication 15 lists payments it can reach, including interest, dividends, rents, royalties, commissions, nonemployee compensation, and payment card and third-party network settlements. It does not apply to wages, pensions, annuities, IRAs, HSAs, long-term care benefits or real estate transactions. For payments under sections 6041(a) and 6041A(a) made in 2026, P.L. 119-21 raised the aggregate reportable payment threshold from $600 to $2,000, and that threshold is adjusted for inflation after 2026 (Publication 15 (2026)).

How an employer handles backup withholding. (1) Request a TIN from each contractor or other payee, using Form W-9 when the payee must certify the number or its backup withholding status (Publication 15). The Instructions for the Requester of Form W-9 list exempt payees; corporations are generally exempt for payments under sections 6041 and 6041A, but attorneys' fees and medical and health care payments to corporations are not. (2) If no TIN is furnished, withhold 24% until it is. An "Applied For" awaiting-TIN certificate gives 60 days only for interest, dividends and certain readily tradable instruments; nonemployee compensation is subject to backup withholding immediately (General Instructions for Certain Information Returns, part N). (3) If the IRS sends a CP2100 or CP2100A notice of an incorrect name/TIN combination, Publication 1281 says to send the first "B" notice and a Form W-9 within 15 business days, begin withholding no later than 30 business days after the notice date or receipt, whichever is later, and stop no later than 30 calendar days after receiving a signed Form W-9. A second notice for the same TIN within three calendar years requires a second "B" notice, and the payee must then provide a copy of a Social Security card or IRS Letter 147C before withholding stops. (4) Report the payment and the withholding on the Form 1099 even if the payment is below the normal filing threshold, and report the withholding on Form 945, line 2 (General Instructions; Instructions for Form 945). A payor that does not collect backup withholding as required may become liable for the uncollected amount.

H-2A workers. If an H-2A worker provides no TIN and annual wages are at least $2,000 in 2026, Publication 15 says the employer must backup withhold; the Instructions for Form 945 put the wages and withholding on Form 1099-MISC and Form 945, line 2.

Retirement plan distributions. Section 3405 sets two flat rates. A payor must withhold 20 percent of an eligible rollover distribution that is not paid as a direct rollover, and 10 percent of a nonperiodic distribution unless the payee elects otherwise. Publication 15-A (2026) explains the Form W-4R rules: for eligible rollover distributions the payee may choose a rate above 20% but never below it; for nonperiodic payments the payee may enter any rate from 0% to 100%, except that it cannot be less than 10% for payments delivered outside the United States and its territories, and a form without the payee's correct SSN means 10% is withheld. Hardship distributions and required minimum distributions are not subject to the mandatory 20%, and nothing is withheld if the entire distribution is transferred in a direct rollover. Publication 15 adds that some nonqualified deferred compensation distributions to participants are wages reported on Form 941, while those to a beneficiary or estate go on Form 945.

Payments to nonresident aliens. Publication 515 (2026) says the wages of nonresident alien employees are subject to graduated withholding like those of U.S. citizens and residents, and are generally not subject to the 30% withholding. The 30% statutory rate does apply to compensation for independent personal services performed in the United States by a nonresident alien contractor, unless the alien has a withholding agreement with the IRS or a final payment exemption. Publication 15-A says pension and annuity payments to nonresident aliens are generally subject to 30% withholding under section 1441 absent a treaty exemption. Chapter 3 withholding goes on Form 1042, not Form 945 (Publication 15).

Golden parachute excise tax. Publication 15-A says the recipient of an excess parachute payment owes a 20% nondeductible excise tax, and if the recipient is an employee the corporation must withhold it. In its example, a $400,000 payment to an officer whose average compensation was $100,000 has a $300,000 excess, so the corporation withholds $60,000.

Example 1 (illustration): crossing $1 million. In 2026 an employee has received $950,000 of supplemental wages and income tax is withheld from regular pay. A separately paid $120,000 bonus brings the total to $1,070,000. The first $50,000 may take the 22% optional rate ($11,000) and the remaining $70,000 must take 37% ($25,900), for $36,900. Applying 37% to the whole bonus would mean $44,400.

Example 2 (illustration): contractor with no TIN. A business pays a contractor a $3,000 fee in 2026 and the contractor has not furnished a TIN. The business withholds 24%, or $720, pays $2,280, reports both amounts on Form 1099-NEC and reports the $720 on Form 945.

Example 3 (illustration): plan distribution. A former employee takes a $10,000 eligible rollover distribution paid directly to them. The payor must withhold at least $2,000 (20%); a direct rollover of the full amount would have no withholding.

Flat supplemental rates in the states. State income tax withholding follows state rules, as covered under state withholding tax. Two examples, not a survey. California's 2026 Employer's Guide (DE 44) says supplemental wages paid with regular wages must be treated as regular wages; when paid separately, the employer may use a combined calculation or withhold 10.23% on bonuses and stock options and 6.6% on other types, such as overtime, commissions, sales awards, severance and vacation pay, without allowing for withholding allowances. New York's 2026 withholding publication (NYS-50-T-NYS) says that if income tax is withheld from regular wages, separately paid or separately stated supplemental wages may be withheld at the New York State supplemental rate of 11.70%, or by the aggregate method; if not, the aggregate method applies. On a separately paid $5,000 bonus, that is $511.50 in California or $585 in New York State, alongside $1,100 federal at 22%.

Flat-tax states are a different idea. In states with a single income tax rate, regular withholding is itself a flat percentage. Two examples: the Pennsylvania Department of Revenue says employers withhold personal income tax at a flat 3.07% of compensation from resident and nonresident employees earning income in Pennsylvania, and the Illinois Department of Revenue says 4.95% is withheld from employee compensation based on the allowances the employee claims. Other states differ; check your state revenue agency.

Recordkeeping. Publication 15 says to keep employment tax records for at least 4 years. The General Instructions for Certain Information Returns say to keep copies of information returns for 4 years if backup withholding was imposed.

Questions employers ask. Does an exempt Form W-4 stop flat withholding? It stops optional flat rate withholding but not the mandatory 37% rate (26 CFR 31.3402(g)-1(a)(2) and (a)(7)(ii)). Can a payee avoid backup withholding by promising a TIN later? Not for nonemployee compensation, which is withheld immediately (General Instructions, part N). This entry describes the rules and is not tax advice.

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