How Your Supplemental Wages Are Taxed
Clarify how tax withholding for supplemental income like bonuses is calculated and how these prepayments factor into your final annual tax liability.
Receiving extra pay outside of a normal salary often brings questions about how that money is taxed. These additional payments, known as supplemental wages, are treated differently for tax withholding purposes than regular paychecks. This guide explains the Internal Revenue Service (IRS) definition of these wages and the methods employers use to calculate withholding.
Identifying Supplemental Wages
Supplemental wages are compensation paid to an employee that is not part of their regular wages. While salary or hourly pay is predictable, supplemental payments often vary in amount and timing. These payments are part of your employment income and are subject to income taxes.
Common examples of supplemental wages include:
- Bonuses
- Commissions
- Overtime pay
- Severance pay
- Payments for accumulated sick leave
- Nondeductible moving expenses
- Awards and prizes
- Back pay
- Retroactive pay increases
If you receive a payment from your employer that is not your standard salary or hourly rate, it is likely classified as supplemental income for tax purposes.
The Percentage Method of Withholding
Employers may use the Percentage Method to calculate tax withholding on supplemental pay, which involves withholding a flat 22% for federal income taxes. This option is available to an employer only if the supplemental wages are paid separately from regular wages or are itemized on the pay stub.
For example, if you receive a $5,000 bonus, your employer would withhold $1,100 for federal income tax ($5,000 x 0.22). This calculation is independent of the information on your Form W-4, such as your filing status or number of dependents.
A special rule applies when an employee’s cumulative supplemental wages for the calendar year exceed $1 million. Once this threshold is crossed, any additional supplemental wages are subject to a mandatory higher withholding rate of 37%. This rate applies to all supplemental payments over the $1 million mark for the remainder of the year, regardless of the withholding method used.
The Aggregate Method of Withholding
When an employer combines supplemental wages with regular wages into a single payment without specifying the amounts, they use the Aggregate Method. The employer treats the entire payment as a single, larger paycheck for that pay period and uses the information on your Form W-4 to calculate the withholding.
The process begins by adding your supplemental pay to your regular wages for the pay period. The employer then consults the IRS withholding tables, using your Form W-4 information. This can push you into a higher marginal tax bracket for that pay period, resulting in a higher effective rate of withholding.
To illustrate, imagine you earn $2,000 in regular wages and receive a $3,000 commission in the same check. Your employer would calculate withholding based on a total income of $5,000 for that period. This larger income figure means a greater amount of tax will be withheld compared to what is taken from your standard paycheck.
Impact on Your Annual Tax Return
The different withholding methods do not change the total tax you owe for the year. Withholding is a system for prepaying your estimated income tax liability, and the amounts withheld are installments toward your final tax bill.
When you file your annual tax return, all your earnings are combined into one total income figure for the year. This income is then taxed according to the standard federal income tax brackets. The total amount withheld during the year, reported in Box 2 of your Form W-2, is subtracted from your total tax liability.
This final calculation determines whether you receive a tax refund or owe an additional amount. If the total withheld from your paychecks is more than your actual tax liability, you will receive a refund. If the amount withheld was not enough to cover your total tax bill, you will have a balance due.