Bonuses, commissions, back pay, overtime paid separately and some other payments are supplemental wages in IRS terms. They are subject to the same taxes as regular wages, but federal income tax withholding can be calculated using special methods described in Publication 15.

What counts as supplemental wages

Supplemental wages include amounts paid in addition to regular wages, such as:

  • Bonuses and awards
  • Commissions
  • Overtime pay, when paid separately from regular wages
  • Back pay and retroactive pay increases
  • Severance pay
  • Payments for nondeductible moving expenses
  • Taxable fringe benefits, in some cases

The two federal withholding methods

Aggregate method: combine the supplemental payment with regular wages for the period and withhold as if the total were a single payment, then subtract tax already withheld from the regular wages. This is required if you do not separately identify the supplemental amount.

Optional flat rate method: if supplemental wages are identified separately and you withheld income tax from the employee's regular wages, you can withhold a flat percentage on the supplemental amount, as specified in Publication 15 for the year. Many payroll systems default to this method for bonuses.

The $1 million rule

When an employee's supplemental wages for the year exceed $1 million, mandatory flat-rate withholding at the highest income tax rate applies to the excess, regardless of the employee's W-4.

Social Security and Medicare still apply

The special methods apply only to federal income tax. Social Security, Medicare and unemployment taxes apply to bonuses in the normal way. States have their own supplemental withholding rules.

Withholding is not the final tax

Employees sometimes believe bonuses are "taxed at a higher rate." The withholding method may differ, but the bonus is ultimately taxed as part of total income on the employee's return. Over- or under-withholding is settled when they file.

Bonuses and overtime

Nondiscretionary bonuses for non-exempt employees must generally be included in the regular rate for overtime; see FLSA overtime rules.

Gift cards and non-cash awards

Gift cards and cash-equivalent awards are taxable wages and should run through payroll. See business gifts.

In our payroll setup

We create separate earnings codes for bonuses, commissions and retro pay so the correct withholding method and overtime treatment apply automatically. See our payroll services.

Recording bonuses

Accrue year-end bonuses in the period earned if you use the accrual method, and record the payroll taxes on them when paid.

Communicating with employees

Employees are often surprised by the withholding on a bonus. Explain in advance that supplemental wages may be withheld at a flat rate and that the final tax is settled on their individual return. Show the gross bonus and withholding clearly on the pay stub.

Non-cash awards, such as gift cards, are generally treated as supplemental wages too, so route them through payroll.

Key terms

Definitions for terms used in this guide, from our small business glossary:

  • Exempt and Non-Exempt Employees: Non-exempt employees must receive overtime under federal law; exempt employees meet specific tests that remove that requirement.
  • Fringe Benefits: Fringe benefits are forms of pay other than wages, such as health coverage, vehicles or discounts, which are taxable unless an exclusion applies.