Supplemental wages, also known as supplemental incomes, are a combination of the extra money an employee receives in addition to their usual salary or hourly wage. 

Employers aren’t required by law to provide supplemental income, but may choose to do so to enhance employee satisfaction, boost productivity, reduce employee turnover, and attract top talent.

What Qualifies As Supplemental Wages?

The Internal Revenue Service (IRS) has outlined what qualifies as supplemental wages:

  • Bonuses: Bonuses enable employers to recognize and reward their employees, which is great for employee satisfaction and retention. Employers may pay bonuses for excellent performance, reaching a target, signing on, holidays, and length of service. 
  • Commission: Commission is often based on the amount of sales or revenue an employee generates for the business. It is a great way to motivate employees to achieve specific goals and enhance their performance. 
  • Overtime pay: Overtime pay is the money an employee receives when they work more than the standard hours outlined in the Fair Labor Standards Act (FLSA), usually 40 hours a week or 8 hours a day. However, employers can treat overtime pay as regular wages instead of supplemental wages.
  • Tips: When an employee receives a tip from a customer or client, the employer can let them keep it as supplemental wages. However, like overtime pay, employers have the option to treat tips as regular wages instead.
  • Severance pay: Severance pay is compensation provided to employees who are laid off from a company.
  • Stock returns: Some employees are able to purchase shares of their company’s stock at a set or discounted price. As the company succeeds and the value of the shares grows, the employee receives profit as supplemental income. 
  • Education reimbursement: Some companies will reimburse employees who enrol in education that increases their skills, such as online classes and training days.

In most cases, Paid Time Off (PTO) is not considered supplemental pay, as it replaces the regular wages an employee would receive if they were working during this time. However, PTO becomes supplemental wages if it is paid in addition to regular wages.  For example, when unused PTO is paid out in the form of a lump sum as it can’t be carried forward to the following year.

How Are Supplemental Wages Taxed?

The IRS classifies supplemental wages separately for tax purposes. 

If an employer provides supplemental wages, they may be required to withhold taxes from these payments. However, the rate at which an employee’s supplemental wages is taxed depends on how much they earn. 

If the employee earns under $1 million in a single tax year through supplemental wages, the IRS-agreed flat withholding rate is 22%. However, state tax rates for supplemental wages can vary. 

If the employee has made over $1 million in supplemental wages throughout a tax year, the money is taxed at a flat rate of 37%. This is mandatory, even if your employee submitted a Form W4 to claim exemption from federal income tax withholding.

Employers are required to track supplemental wages and report them in quarterly payroll tax filings and on an employee’s annual W2 Form.