Editorial · December 24, 2022
Supplemental Wage Withholding: How Bonuses Are Taxed
Supplemental wage withholding is the set of IRS rules for how much income tax an employer takes out of a bonus or similar extra pay. Most employers pick one of two methods. One takes a flat 22 percent. The other adds the bonus to regular pay and figures the tax on the total.
What counts as supplemental wages
Supplemental wages are pay that is not regular wages. The IRS lists bonuses, commissions, overtime pay, severance pay, awards, prizes, back pay and reported tips. It also lists pay for unused sick leave, retroactive pay raises and some taxable fringe benefits.
Employers may treat overtime pay and tips as regular wages instead. That choice is theirs. A year-end bonus, though, is a clear case of supplemental pay.
Method one: the flat 22 percent rate
The first method is simple. The employer withholds a flat 22 percent of the bonus. No other percentage is allowed under this method.
The IRS gives an example. An employee named Sharon gets a $1,000 bonus. Her employer picks the flat rate and withholds 22 percent of $1,000, which is $220.
The flat rate is often the easier path for payroll teams. It does not depend on the choices an employee made on Form W-4. This method is open to an employer that withheld income tax from the employee's regular wages in the current or the prior calendar year.
Method two: the aggregate method
The second method treats the bonus and the regular pay as one payment. The employer adds the bonus to the wages from a regular pay period. It then figures the tax on the total, as if it were a single paycheck.
Next the employer subtracts the tax already withheld from the regular wages. Whatever is left is withheld from the bonus.
The IRS example uses the same $1,000 bonus. Sharon earned $2,000 on May 1, and $86 was withheld. The employer adds the bonus for a total of $3,000. The tables show $202 of tax on that total. After subtracting the $86, the employer withholds $116 from the bonus.
This can come out lower or higher than the flat rate, depending on pay and on the employee's Form W-4. In the IRS example it is $116 against $220. If a second bonus is paid in the same period, all the payments are added up and the same steps repeat.
When the rules change
Two cases do not follow the usual choice. First, if the employer paid the bonus together with regular wages and did not say how much was which, it withholds as if the total were one regular payment.
Second, there is a high-pay rule. When an employee gets more than $1 million in supplemental wages from one employer in a calendar year, the extra amount is withheld at 37 percent. That is the top income tax rate for the year. The employer uses 37 percent whatever the employee wrote on Form W-4.
If the employer did not withhold income tax from the employee's regular wages in the current or prior year, it must use the aggregate method.
Other taxes still apply
Many people see a bonus check and think the government took a bigger share than usual. Often the cause is only the method, since the flat rate and the aggregate method can give different amounts.
Withholding is only income tax. The IRS says supplemental wages are also subject to social security, Medicare and federal unemployment (FUTA) taxes, whichever method the employer uses.
For employees, the practical point is that a bonus check can look small. The method, not a penalty, explains it. For employers, the method is a choice to make on purpose.
Employers with questions can use the IRS tables in Publication 15-T and the examples in Publication 15.
Sources
- IRS, Publication 15 (Circular E), Employer's Tax Guide, section 7, Supplemental Wages (page last updated December 15, 2022): irs.gov/publications/p15
- IRS, Publication 15-T, Federal Income Tax Withholding Methods (2022): irs.gov/publications/p15t