Supplemental Wages: What It Means for Employers

What it means in practice

Federal income tax withholding treats an employee's pay as one of two kinds. The Treasury regulation defines regular wages as amounts paid at a regular hourly, daily or similar periodic rate (not an overtime rate) for the current payroll period, or a predetermined fixed amount for that period. Supplemental wages are all wages that are not regular wages, and they include payments made without regard to the payroll period (26 CFR 31.3402(g)-1(a)(1)). Pay that varies from period to period, such as commissions, bonuses or overtime, is therefore supplemental. These payments are part of an employee's wages and gross income; the special rules change only how withholding is figured in payroll.

What counts. Beyond the items in the quick facts, the regulation lists wages paid under expense allowance arrangements, nonqualified deferred compensation includible in wages, noncash fringe benefits, sick pay paid by a third party as the employer's agent, and income from exercising a nonstatutory stock option. Publication 15 adds taxable fringe benefits, payments for nondeductible moving expenses and expense allowances paid under a nonaccountable plan. A payment is supplemental even if the employer has never paid the employee regular wages. Amounts that are not wages subject to income tax withholding are neither regular nor supplemental wages; the regulation's example is income from a disqualifying disposition of stock acquired through a statutory stock option.

Overtime and tips by choice. An employer may treat overtime pay as regular wages. For this purpose overtime pay means pay that federal, state or local law requires at a higher rate because the employee worked beyond a normal workweek or workday. An employer may also treat tips reported under section 6053 as regular wages (26 CFR 31.3402(g)-1(a)(1)(iv) and (v)).

Step 1: check the $1 million threshold. Start each supplemental payment by adding it to all supplemental wages already paid to the employee in the calendar year. Any amount over $1 million is withheld at the highest rate under section 1 of the Internal Revenue Code, which Publication 15 (2026) gives as 37%. This rate applies whether or not tax was withheld from regular wages, whatever the employee's Form W-4 says (including an exempt claim or a request for extra withholding), and whatever withholding method the employer uses (26 CFR 31.3402(g)-1(a)(2)). Payments from all businesses under common control count toward the $1 million. Only the part of a payment above the threshold must be withheld at the mandatory rate, but the employer may apply it to the whole payment (26 CFR 31.3402(g)-1(a)(4)(iv)).

Step 2: combined or separately identified. For supplemental wages of $1 million or less, Publication 15 says that if you pay them together with regular wages and do not specify the amount of each, you withhold federal income tax as if the total were a single payment for a regular pay period. In its example, an employee paid $1,000 a month gets a $1,000 salary plus a $500 commission in one February payment, and withholding is figured on $1,500 from the tables ($53).

Step 3: flat rate or aggregate method. If the supplemental wages are separately identified, either paid at a different time or stated separately on the payroll records, and income tax was withheld from the employee's regular wages in the current or preceding calendar year, the employer may choose either method (26 CFR 31.3402(g)-1(a)(7)). Under the optional flat rate method, Publication 15 says to withhold a flat 22%, with no other percentage allowed. That figure is made without reference to regular wages and without regard to Form W-4 entries other than a claim of exempt status. Under the aggregate method, supplemental wages paid with a regular payroll are added to that period's wages; if paid separately, they are added to the wages for the current or most recent payroll period in the same year. Tax is figured on the total as one payment using the employer's regular method and the employee's Form W-4, and the tax already withheld from the regular wages is subtracted (26 CFR 31.3402(g)-1(a)(6)). If no income tax was withheld from regular wages in the current or preceding year, the aggregate method is required.

Social Security, Medicare and FUTA. Whatever income tax method is used, Publication 15 says supplemental wages are subject to Social Security, Medicare and FUTA taxes. For 2026 the IRS lists Social Security at 6.2% each for employee and employer on wages up to $184,500, and Medicare at 1.45% each with no wage base limit. Employers also withhold 0.9% Additional Medicare Tax on wages above $200,000 in a calendar year, starting in the pay period when wages pass that amount, with no employer match (IRS Topic 751). See FICA.

Form W-4 interactions. Publication 15-T (2026) says employees who claim exemption on Form W-4 have no federal income tax withheld except in the case of certain supplemental wages, and that its wage bracket and percentage methods cannot be used when the 37% mandatory rate or the 22% optional flat rate is used. An exempt claim is respected under the optional flat rate but not the mandatory rate (26 CFR 31.3402(g)-1(a)(2) and (a)(7)(ii)).

Taxable fringe benefits. Publication 15-B (2026) says any fringe benefit you provide is taxable and must be included in the recipient's pay unless the law specifically excludes it, generally at fair market value. For income tax, an employer may add the value to regular wages for a payroll period, or withhold at the 22% flat rate (37% above $1 million). Benefits may be treated as paid by pay period, quarter, half-year, year or another basis, but no less often than annually, and under a special accounting rule benefits provided in November and December may be treated as paid the next year. An employer may elect not to withhold income tax on an employee's personal use of a company vehicle, with written notice, but must still withhold Social Security and Medicare tax. Cash and cash equivalents, including gift cards, are never excludable as a de minimis benefit, however small. The value is reported on Form W-2 in box 1 and, if applicable, boxes 3 and 5.

Tips and vacation pay. Publication 15 says income tax on tips is withheld from the employee's wages or other funds the employee makes available, not from the tips. If an employee has regular wages and reports tips, withholding is figured as if the tips were supplemental wages, and service charges are not tips. Vacation pay is withheld as regular wages for the vacation period, but vacation pay paid in addition to regular wages for that period, such as a lump sum for unused leave, is supplemental (26 CFR 31.3402(g)-1(c)). See paid time off (PTO).

Bonuses and the FLSA regular rate. How a bonus is taxed does not decide whether it affects overtime for non-exempt employees. The regular rate includes all pay except eight types the statute excludes, and bonuses that do not fit an exclusion must be added in (29 CFR 778.208). A discretionary bonus is excluded only if the employer keeps discretion over both the fact and the amount of payment until near the end of the period, with no prior promise. Bonuses promised on hiring, announced to encourage steadier or faster work, or paid for attendance, production, quality or staying employed must be included, whatever their label (29 CFR 778.211). Bonuses that may be discretionary include severance bonuses, referral bonuses for employees not mainly recruiting, and employee-of-the-month awards. A true gift at Christmas or another occasion can be excluded if it is not measured by hours, production or efficiency (29 CFR 778.212). A bonus contracted as a percentage of both straight-time and overtime earnings satisfies overtime without recomputation, unless it is used to evade the Act (29 CFR 778.210).

Where states differ. States set their own income tax withholding rules. One example: the California Employment Development Department's 2026 California Employer's Guide (DE 44) says supplemental wages paid at the same time as regular wages must be treated as regular wages and withheld under the state schedules. When paid separately, the employer may use a combined calculation or a flat rate of 10.23% for bonuses and stock options and 6.6% for other types, such as overtime, commissions, sales awards, severance and vacation pay, without allowing for withholding allowances. On a separately paid $4,000 bonus that is $409.20. Unlike the federal flat rate, California's does not apply just because a bonus is stated separately on the same check. Other states differ, so check your state revenue agency.

Garnishment. For federal wage garnishment limits, the Department of Labor says earnings include commissions and both discretionary and non-discretionary bonuses, and lump sums count if the employer paid them for the employee's services. See garnishment.

Recordkeeping. Publication 15 says to keep all employment tax records for at least 4 years. Year-to-date supplemental totals are what the $1 million test runs on.

Questions employers ask. Can we withhold 25% instead of 22%? Not under the optional flat rate method; Publication 15 says no other percentage is allowed. Is a holiday gift card supplemental wages? Publication 15-B says gift cards are never de minimis, so the value is a taxable fringe benefit subject to the supplemental rules. Is severance supplemental? Yes for withholding (Publication 15); separately, a severance bonus may be discretionary for FLSA purposes (29 CFR 778.211(d)). Can we use the flat rate for a bonus on a regular paycheck? Federally, yes if it is separately stated in payroll records and the other conditions are met (26 CFR 31.3402(g)-1(a)(7)); some states, like California, differ.

This entry is not tax or legal advice. Confirm current rates with the IRS, your state agency or a qualified professional.

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