What Is Supplemental Pay and How Is It Taxed?
Navigate the complexities of supplemental pay, from its types to crucial details on how these earnings are taxed and reported.
Supplemental pay represents additional compensation provided to an employee beyond their regular wages. This type of payment is often disbursed for specific achievements, under particular conditions, or as an extra benefit.
Understanding Different Types
Supplemental pay encompasses a variety of common forms, each serving distinct purposes in employee compensation. Bonuses are a frequent example, including performance-based incentives, sign-on bonuses, or retention bonuses. Commissions, typically found in sales roles, are another type, where earnings are based on a percentage of sales or revenue generated by an employee.
Overtime pay, when compensated for hours worked beyond an employee’s standard schedule, can also qualify as supplemental wages. Severance pay, provided to employees upon termination of employment, and payouts for accumulated but unused sick or vacation leave are further instances of supplemental compensation. Taxable fringe benefits, such as cash equivalents for certain perks, also fall under this category. Other types include back pay, retroactive wage increases, and awards or prizes.
How Supplemental Pay is Taxed
Federal income tax withholding on supplemental pay follows two primary methods: the percentage method and the aggregate method. If supplemental wages are identified separately from regular wages, employers often use the percentage method. This involves withholding federal income tax at a flat rate of 22% for amounts up to $1 million. For any supplemental wages exceeding $1 million within a calendar year, the amount over that threshold is subject to a mandatory 37% federal income tax withholding.
The aggregate method applies when supplemental wages are combined with regular wages in a single payment. Under this method, supplemental wages are added to the employee’s regular wages for the current or most recent payroll period. Federal income tax is then calculated on this combined total as if it were a single payment, considering the employee’s Form W-4 and applicable withholding tables. The tax already withheld from regular wages is then subtracted, with the remainder being the tax withheld from the supplemental portion. The chosen withholding method impacts how tax is collected throughout the year, but it does not change an individual’s ultimate tax liability, which is determined when filing their annual income tax return.
Beyond federal income tax, supplemental pay is also subject to Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare. For 2025, the Social Security tax rate is 6.2% for both the employee and the employer, applied to wages up to the annual wage base limit of $176,100. The Medicare tax rate is 1.45% for both the employee and the employer. Unlike Social Security, there is no wage base limit for Medicare tax, meaning all covered wages are subject to this tax.
An additional Medicare tax of 0.9% applies to wages exceeding certain thresholds: $200,000 for single filers, $250,000 for married couples filing jointly, and $125,000 for married individuals filing separately. This additional tax is only withheld from the employee’s wages, with no employer matching contribution for this portion. Many states and some local jurisdictions also impose their own income taxes on supplemental wages, with varying rates and rules.
Where Supplemental Pay Appears
Supplemental pay is recorded and reported through standard payroll documentation, similar to regular wages. On an employee’s pay stub, supplemental payments may be listed as separate line items or combined with regular wages, depending on the employer’s payroll system. Employers are responsible for accurately tracking and reporting all supplemental wages.
Supplemental pay is included as part of an employee’s total taxable wages on Form W-2, Wage and Tax Statement. These additional earnings are reported in Box 1, labeled “Wages, tips, other compensation,” alongside an employee’s regular earnings. It contributes to the overall taxable wage amount.