Supplemental wages, or payments made in addition to an employee’s ordinary wages, are in a league of their own when it comes to taxes and government regulations. They are subject to Social Security and Medicare taxes, separate state-specific withholding practices and state labor department requirements, increasing the complexity of compliance.
Due to increased Department of Labor crackdowns on wage and hour violations under the Fair Labor Standards Act, there has never been a more urgent time to understand supplemental wages. With audits and investigations becoming more and more common thanks to increased IRS funding, the consequences for mishandling supplemental wages are more serious than ever.
Quick facts about supplemental wages
Supplemental wages include, but are not limited to:
- Severance pay
- Overtime pay
- Taxable fringe benefits such as unused vacation or sick days
- Back pay
- Retroactive pay
It is important to understand the difference between supplemental and regular wages because the two types are subject to different federal wage laws and different withholding practices. For example, whereas regular wages must be paid within seven days of the end of the determined pay period, supplemental wages do not, and therefore the two can be paid at different times.
As far as withholding procedures for supplemental wages, there are a few different ways to handle them. Regular wages are usually withheld based on marital status and numbers of withholding allowances, but supplemental wages are not.
To withhold taxes on supplemental wages, an employer can add together the entirety of the employee’s wages (supplemental and regular) and withhold taxes on the entire amount. Or, employers can tax supplemental wages at a flat rate of 25%. The IRS does not allow any other rate. Finally, the employer can perform a complicated calculation to figure the tax withholding on the supplemental wages and regular wages separately.
And there is more: if the supplemental wages do not exceed one million dollars, employers can choose to combine and tax all the wages or they can use the flat 25% rate. But if the supplemental wages do exceed one million dollars, the employer must withhold a 35% tax on the excess amount after one million dollars.
Further, there are exceptions on how to treat vacation and tips. Vacation pay is treated as a supplemental wage if the pay is more than the regular wages that would be paid during that time. Tips are treated as supplemental wages if the employee receives wages and tips. If the employer does not withhold tax from the regular wages, tips are added to the regular wages and the entire amount is taxed. However, if the regular wages are taxed, tips are withheld at 25%.
Between the federal regulations described here and the taxation rules in each U.S. state, supplemental wages can make your head spin. Now more than ever, wage and hour missteps are not ones you can afford to make. It’s a smart choice to partner with an expert to protect your business from costly penalties: find out how Paycor’s intuitive HR and payroll solutions can help you stay compliant with supplemental wage regulations.
Source: U.S. Department of Labor
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