What Does Supplement Pay Mean and How Is It Taxed?

Supplemental pay refers to additional payments employees receive beyond their regular wages. These payments differ from an employee’s standard salary or hourly pay, which is typically consistent. Supplemental pay is considered taxable income. Understanding how these earnings are defined, taxed, and reported is important for employees.

Understanding Supplement Pay

Supplemental pay encompasses various forms of compensation. The Internal Revenue Service (IRS) defines these as wage payments that are not regular wages and often vary from pay period to pay period. Regular wages, by contrast, are typically a fixed amount paid for a payroll period, such as an hourly rate or a predetermined salary.

Common examples of supplemental wages include bonuses, often performance-based incentives. Commissions, based on sales or metrics, also fall under this category. Severance pay upon leaving a position, and payouts for unused sick leave or vacation time are further instances of supplemental pay. Certain types of overtime pay may also be classified as supplemental, particularly if paid separately from regular wages.

Other forms of supplemental compensation include awards, prizes, back pay, and retroactive pay increases. Taxable fringe benefits and nonaccountable expense allowances also qualify as supplemental wages.

Taxation of Supplement Pay

Supplemental pay is subject to federal income tax withholding, though the method of withholding can differ from regular wages. Employers typically use one of two methods for federal income tax withholding on supplemental wages: the percentage method or the aggregate method. For supplemental wages totaling $1 million or less within a calendar year, employers can choose to withhold federal income tax at a flat rate of 22%. This flat rate is often applied when supplemental wages are paid separately from regular wages.

Alternatively, employers may use the aggregate method, especially if supplemental wages are combined with regular wages. Under this method, the supplemental wages are added to the employee’s regular wages for that pay period. The employer then calculates the income tax withholding on the total amount as if it were a single regular payment, using the employee’s Form W-4. After determining the total withholding, the tax already withheld from the regular wages is subtracted, and the remaining amount is withheld from the supplemental wages.

Regardless of the withholding method used, supplemental wages are ultimately subject to the same income tax rates as other income when an individual files their annual tax return. The initial withholding is an estimate, and the actual tax liability is determined by the taxpayer’s overall income, deductions, and credits. If too much tax was withheld, an employee may receive a refund; if too little, they may owe additional tax. For supplemental wages exceeding $1 million within a calendar year, any amount over $1 million is subject to a mandatory federal income tax withholding rate of 37%.

Reporting Supplement Pay

Employers are responsible for accurately tracking and reporting all forms of compensation, including supplemental pay. On an employee’s pay stub, supplemental wages are often itemized separately from regular wages, providing clarity on the nature and amount of each payment. This separate listing helps employees understand the components of their earnings and the corresponding tax withholdings.

At the end of the tax year, employers provide employees with Form W-2, Wage and Tax Statement, which summarizes all compensation and withholdings. Supplemental wages are generally included in Box 1 of Form W-2, labeled “Wages, tips, other compensation,” along with regular pay. This means that while withholding might occur differently throughout the year, the total amount of supplemental pay is combined with regular wages for annual reporting purposes. The W-2 also details federal, state, and local taxes withheld, allowing employees to reconcile their earnings and withholdings when preparing their tax returns.