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Pay Attention to Federal Taxation of Supplemental Pay, Advises APA

BY: Alice P. Jacobsohn, Esq. | 11/07/19

The SSA/IRS Reporter, Fall 2019, contains an article written by APA on supplemental wages and federal taxation, including how the IRS defines supplemental wages, methods to calculate withholding, the impact of new fringe benefit rules under the Tax Cuts and Jobs Act (TCJA), and where to find more information.

Under the TCJA, the rates for withholding on supplemental wages were changed. The optional flat rate on supplemental wages of up to $1 million in a taxable year is 22%, with no other percentage allowed. The mandatory flat rate exceeding $1 million in a taxable year is 37%.

Two Withholding Methods

The article, “Understanding Supplemental Wages and Federal Taxation Rules,” explains that employers have two options to calculate withholding of supplemental wages:

  1. Add supplemental wages to the employee’s regular pay, combine the pay amount on payroll records, and withhold income taxes in accordance with the employee’s Form W-4 (aggregate method); or
  2. Pay the wages separate from regular pay, record the amount separately on payroll records, and withhold income taxes using the optional flat rate (percentage method).

The option selected can make a significant difference to employees, especially if their annual tax rate is less than 22%. For example, if an employee’s tax rate is 12%, and the employer selects the percentage method, the employee will be taxed on the supplemental wages at an amount that is almost twice as high.

Fringe Benefits

Employers should pay careful attention to the fringe benefit changes in the TCJA. For example, commuter benefits still cover parking and public transportation, but the bicycle benefit was eliminated. Vacation pay may be included in an employee’s regulate pay or could be in addition to regular wages. When this occurs, the IRS considers the vacation pay as supplemental wages.

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Alice P. Jacobsohn, Esq., is Senior Manager of Government Relations for the APA.