What Is Payroll Tax: Everything Employers Need To Know
What is payroll tax? At first glance, payroll tax can be confusing and opaque fo...
If you’re a business owner or manager in charge of payroll, you’ve probably heard the words “supplemental wages” spoken in hushed, almost fearful tones. That’s because dealing with supplemental wages in your business may seem difficult at first.
There are many misconceptions about supplemental wages vs. regular wages and the rules regarding timing, calculation, and withholding. But supplemental wages aren’t as undecipherable as you might first suspect. With just a bit of practice, you’ll be calculating supplemental wages like a pro.
In this guide, we discuss everything you need to know about supplemental wages and how to use them in your business.
According to the Internal Revenue Service’s Employer’s Tax Guide (Circular E), supplemental wages are exactly what they sound like: supplemental pay or other compensation given to an employee in addition to their regular wages.
This is a fairly broad definition, but for good reason. The IRS considers many types of employee remuneration as supplemental wages, including but not limited to:
As you can see, supplemental wages aren’t all that uncommon. You might already be using them without even knowing it. But it’s how you pay — and, ultimately, how you withhold taxes for — those supplemental wages when compared to regular wages that makes all the difference.
The main difference between supplemental wages and regular wages is how they’re taxed. And that tax rate comes down to two simple variables:
For example, if you pay an employee more than $1,000,000 in supplemental wages per year, those wages are taxed in a specific way (regardless of how you paid them).
If you pay an employee less than $1,000,000 in supplemental wages per year, those wages are taxed based on how you paid them — either combined with or separate from regular wages.
Supplemental wages in excess of $1,000,000 are subject to withholding at 37 percent (or the highest rate of income tax for the year). Here’s an example:
Supplemental Wages = $1,500,000
Tax Rate = 37% (or 0.37 in decimal format)
The equation for figuring out withholding would then look like this:
Withholding = $1,500,000 x 0.37
Withholding = $555,000
In addition, that withholding is done without regard to the employee’s W-4 form.
If you pay supplemental wages with regular wages (i.e., in the same check) but don’t specify the amount of each, you would withhold federal income tax as if the total were a single payment for a regular payroll period.
That means you would determine withholding based on the employee’s W-4 on the IRS tax tables. Here’s an example:
Your single employee indicated 0 withholding allowances on her W-4. She earns $700 per week. One week, you give her a $400 bonus. This bonus is technically supplemental wages, but you lump it together with her regular wages without specifying the dollar value of either (supplemental or regular wages).
After checking the IRS’s Tax And Earned Income Credit Tables for your current year, you find that you have to withhold $111 from the combined regular and supplemental wages.
If you pay supplemental wages separately from regular wages, you have two options:
Here’s how each works out.
If you pay your employees’ supplemental wages separate from their regular wages (i.e., in different checks), you would withhold 22 percent of those wages for taxes. Here’s an example:
Supplemental Wages = $350
Tax Rate = 22% (or 0.22 in decimal format)
The equation for figuring out withholding would then look like this:
Withholding = $350 x 0.22
Withholding = $77
It’s important to remember that you also have to withhold income tax from their regular wages based on their W-4.
In this case, you would figure the income tax withholding as if the total of the regular wages and supplemental wages is a single payment.
First, add together the regular and supplemental wages. Then find the tax liability on the combined amount. This is exactly the same as the example given in the Combined With Regular Wages section above:
$700 regular wages + $400 supplemental wages = $1100
Tax withheld = $111
But, in this case, you now have to do a few more calculations.
Next, determine the tax liability for the employee’s regular pay of $700 (i.e., $71). Finally, subtract the tax liability for the employee’s regular pay ($71) from the total tax liability ($111):
$111 total tax liability – $71 regular pay liability = $40
That $40 is the amount you would withhold as a tax on the employee’s supplemental wages.
As you can see, dealing with supplemental wages can be a chore and make payroll difficult. But you can get control with the right tools.
Responsibility for reporting supplemental wages rests entirely with the employer who pays said wages.
The employee will, of course, have to claim any supplemental wages on their tax return, but their numbers must ultimately match the numbers that you report throughout the year.
At its most basic, that’s how the IRS keeps track of all monies that change hands: Employers submit reports several times a year, and then employees report their earnings after the end of the calendar year.
If there’s a discrepancy between what the employer reports and what the employee reports, the IRS may investigate.
The best thing you can do to manage your program — whether you’re revamping an existing system or setting up a new one — is talk to a tax professional.
They can help you understand and satisfy all the tax-reporting and submission requirements that the federal government levies on businesses in the United States.
The Internal Revenue Service’s website (irs.gov) is a wealth of information about supplemental wages. We recommend reading this information in full or reviewing it with a tax professional to make sure you understand it (and abide by it) fully.
In addition to making supplemental wages clearer, the IRS website also provides a general idea of how to better structure your business’s payroll system so that it’s easier to manage throughout the year and when it comes time to submit tax reports.
As part of the payroll process, your business must keep records of everything paid to employees, including:
Businesses must also create and keep records of all supplemental wages paid throughout the year. Store these records for at least four years after reporting them on your tax return.
Depending on where your business operates, it may be subject to local laws and taxes on all payroll produced and distributed during a calendar year.
This may include any necessary reporting (quarterly and annually) that coincides with payments of wages and benefits of all types.
Local reporting and payment laws are less common than state and federal requirements, but check with your city or county government or consult a corporate attorney who is familiar with the type of business you run and the area in which it operates just to be sure.
The majority of states require that businesses submit reports related to various aspects of payroll (possibly including supplemental wages).
Whether your business is in a reporting or non-reporting state, it’s always a good idea to check your state’s website for details. Every state has slightly different rules, and you want to make sure you’re compliant.
Here are just a few of the possible differences from one state to another:
Being consistent with your state-mandated payroll reports can save you significant time, headaches, and fines down the road.
The federal level is where you’ll find the bulk of the quarterly and annual payroll reports that may include supplemental wages.
The Internal Revenue Service’s Publication 15, (Circular E), Employer’s Tax Guide is a valuable resource for helping you identify all the necessary info and reporting deadlines you’ll need to abide by.
The entire document is a wealth of information for business owners, but be sure to check out section seven (Supplemental Wages) for more details.
Sometimes, wages can change from regular to supplemental and vice versa.
Two examples of this are tips and vacation pay.
At times, tips may be treated as supplemental wages.
In that case, the IRS stipulates that you should withhold income tax on tips from wages earned by the employee or from other funds the employee makes available. Don’t withhold the income tax due on tips from employee tips.
If an employee receives regular wages and reports tips, figure income tax withholding as if the tips were supplemental wages.
If you withheld income tax from the regular wages in the current or immediately preceding calendar year, you can withhold on the tips by the methods mentioned in the section Separate from regular wages from earlier in this article.
If you didn’t withhold income tax from the regular wages in the current or immediately preceding calendar year, add the tips to the regular wages and withhold income tax on the total by the method mentioned in the section Combined with regular wages from earlier in this article.
Employers also have the option to treat tips as regular wages rather than supplemental wages. Service charges aren’t tips; therefore, withhold taxes on service charges as you would on regular wages.
Like tips, vacation pay may be treated as supplemental wages at times. Vacation pay is subject to withholding as if it were a regular wage payment.
But when vacation pay is in addition to regular wages for the vacation period (for example, an annual lump-sum payment for unused vacation leave), treat it as a supplemental wage payment.
If the vacation pay is for a time longer than your usual payroll period, spread it over the pay periods for which you pay it.
As you can see, supplemental wages can be complicated at times. The best solution to these difficulties is to consult with a tax professional who is familiar with your industry and the area in which it operates.
Supplemental wages are just a small part of the entire payroll reporting process.
If you’re focusing on these — because you’re implementing a new program or overhauling an existing one — do your best not to neglect the other aspects of your payroll in the process.
You’ll still need to produce and file a number of forms or risk possible audit by the IRS. Those federal forms are 941, 944, 940, W-2, and W-3.
Here’s a brief description of what the form is for and when it’s due.
Use Form 941 to report the following information as it pertains to employee payroll:
Form 941 must be filed every three months and is due by the last day of the month following the end of a quarter (i.e., April 30, July 31, October 31, January 31).
In some instances, your business may be eligible to file Form 944 instead of Form 941. Both reports contain the same information, but Form 944 is filed annually instead of quarterly.
Only certain businesses may use Form 944 and it depends on the total amount of social security, Medicare, and federal income taxes you withhold each year.
The IRS will notify you if you are eligible to file Form 944 instead of Form 941. Form 944 is due January 31 following the end of the current year.
Form 940 is a payroll report submitted annually that indicates federal unemployment tax (FUTA) paid during the year.
Federal unemployment tax does not come out of your employees’ paychecks but is paid directly by your business.
Form 940 is due January 31 following the end of the current year.
Form W-2 summarizes an employee’s gross pay for the year and includes information on how much you withheld for local, state, and federal deductions (based on the employee’s specifications on Form W-4).
By law, you must distribute Form W-2 to every employee who worked for you during the year. You also submit W-2s to the state and federal government so they can verify wage and tax amounts.
W-2s are due by January 31 following the end of the current year.
Form W-3 is the document you use to submit Form W-2 to the Social Security Administration. It summarizes all the W-2s for your business.
Like the W-2s, it is due by January 31 following the end of the current year.
Calculating supplemental wages vs. regular wages may sound like tedious and confusing work (and it can be if you’re doing it for several employees). But software like Sling can significantly reduce the time it takes to process all the necessary information.
Sling has the tools you’ll need to deal with all types of payroll, including:
And when you use Sling to get control of the many aspects of your business, it can have a serious impact on your bottom line.
For more free resources to help you manage your business better, organize and schedule your team, and track and calculate labor costs, visit GetSling.com today.
Please note that this is not an exhaustive explanation of how to handle supplemental wages. Some of the information may differ slightly based on your business and where it operates.
Be sure to review all federal, state, and local requirements — or consult with a professional — before calculating your own supplemental wages.
This content is provided for informational purposes only and is not legal, accounting, tax, HR, or other professional advice. You should contact your attorney or other relevant advisor for advice specific to your circumstances.