Supplemental pay is any compensation you pay your employees in addition to their base salary or wages. Things like performance-based bonuses, shift differentials, and overtime are common examples of supplemental pay.
Normally, supplemental pay is taxed just like regular earnings. Consider this your guide to knowing what is—and isn’t—supplemental pay and how you should report it to Uncle Sam.
What Counts as Supplemental Pay?
- PTO payouts/cashouts
- Severance pay
- Relocation reimbursements
- Shift differentials
Let’s take a closer look using three examples.
Scenario A: Overtime
During the holiday season, you allow employees to schedule 50-hour workweeks to help deal with the chaos. The more hands on deck, the better. You even offer to pay double overtime.
Five of your employees who typically earn $15 per hour sign up for 50-hour workweeks. At the end of the two-week pay period, you pay them each $30 per hour for the 10 extra hours of work. That’s an extra $600 of supplemental pay for each of the five employees.
Scenario B: PTO Payouts/Cashouts
During one pay period, one of your employees leaves the company. This person has accumulated 100 hours of unused PTO. It’s your company policy (and potentially state law) to pay out unused PTO. You’ve set a cap for up to 200 hours when an employee parts ways with your organization.
This employee made $25 an hour, which means you’ll need to pay out $2,500 in supplemental pay.
In that same pay period, another employee goes on a 10-day vacation. Since they had accrued 100 hours of PTO before the vacation, they’re now down to 20 hours. Your HR department will pay them their normal wages for the 80 hours they were on vacation.
This does not count as supplemental wages because it’s not a PTO payout or cashout. It’s simply an employee using their paid vacation days as intended.
Scenario C: Relocation Reimbursements
Your engineering firm in Alaska has hired three new employees, all of whom live out of state. Like many employers, you provide relocation reimbursements for employees who relocate to join your team.
So let’s say these three employees—Jen, Pablo, and, Rasheed—all live in different states before they move. Jen lives in Michigan, Pablo lives in Texas, and Rasheed lives in Pennsylvania.
All three employees receive full-service moving, from packing to loading trucks to cross-country transportation. Jen and Rasheed each have two cars to ship to Alaska. Pablo has one.
Rasheed decides to fly from Pennsylvania to Alaska with his family of four. You pay for all of their plane tickets.
Jen and Pablo each decide to turn the move into an epic road trip. You’ll reimburse them for gas, mileage, food, and lodging.
Every single penny spent toward purchasing moving services or reimbursing these three new employees counts as supplemental pay.
And each scenario has something in common: the employer pays the employee compensation that goes above their normal pay range.
That’s the rule of thumb for knowing what counts as supplemental pay.
What Doesn’t Count as Supplemental Pay
- 401(k) matches
- Charitable contribution matches
- Jury duty pay
- Health, dental, vision, and life insurance
Let’s explore these non-supplemental forms of compensation.
Scenario A: PTO
Are you confused to see PTO named on this list and the one before it?
We get it. But if you look closely, you’ll notice we said PTO payouts/cashouts in the section before this one.
Paid time off alone doesn’t count as supplemental pay.
Remember the rule of thumb? Only pay that goes above a person’s normal wages or salary is considered supplemental pay.
If an employee goes on vacation for a week, using five days of PTO, she’s just getting her regular salary for those days. On her paystub for that pay period, her paycheck will have the same amount of money as it would otherwise. She’ll just have enjoyed five paid days when she didn’t have to work.
But if this employee had accumulated 200 hours of PTO and received a cashout as per her company’s policy, that would show up as extra money on her paycheck. That’s why PTO cashouts and payouts count as supplemental pay while regularly used PTO does not,
Scenario B: 401(k) Matches
Many employers offer 401(k) matches up to a certain percent of an employee’s overall compensation.
Let’s imagine that an employee makes $75,000 a year. You offer a 401(k) match of up to 6% of the employee’s total salary.
All year long, the employee designates 10% of each paycheck for retirement. Her total contribution for the year is $7,500. Since you match up to 6% of her income, you pay $4,500 throughout the year toward her 401(k).
This chunk of change might feel like a supplemental contribution, but your employee doesn’t get to use it right away. She’ll probably have to wait a while before she’ll directly benefit from it.
That’s why these contributions don’t count as supplemental income.
Scenario C: Health, Dental, Vision, and Life Insurance
Insurance benefits are incredibly valuable for employees. They help your team to pay for basic needs without breaking the bank. Some types of healthcare bills, like medical and dental, usually get billed to the insurance company your company uses.
But some insurance plans reimburse employees directly. Life insurance is an obvious example.
We’ll say an employee, Sue, suffers the loss of her spouse, Dan. Through your company, Sue has a life insurance policy that pays out $300,000 if she passes away and $100,000 if her spouse passes away.
So Sue receives $100,000 from the policy after Dan’s death.
Does this count as supplemental income?
No. For one thing, you’re not paying the money out as a business—the insurance company is. You contributed to the monthly premiums, but the employee may have as well, depending on the policy.
Plus, according to the IRS, life insurance payouts don’t count toward gross income. They are also not taxable—although any interest gained from keeping the funds in savings or investment accounts is.
This means Sue does not have to report her $100,000 payout. But if she puts $90,000 in a high-yield savings account that pays 5% interest each year, she’d need to pay taxes on the $4,500 in interest.
How Supplemental Pay Is Taxed
You might be wondering why it’s important for employers to understand what does and doesn’t count as supplemental pay.
The biggest reason? Employers are responsible for reporting supplemental pay to the IRS.
The IRS outlines three scenarios with instructions for each one. It gets a little complicated, so make sure you have a good payroll service to help you keep things organized.
Report Supplemental Pay with Regular Wages
Let’s say your employees’ regular and supplemental wages regularly appear on the same paycheck. You don’t spell out which amounts count as what type of wage—everything’s just lumped together.
If this is the case, you will report supplemental pay along with regular wages.
For example, let’s imagine one of your employees receives a PTO cashout at the end of the year. The amount, $700, is lumped into the gross pay on her regular pay stub. It’s not listed as a separate item.
In this case, you would just withhold federal income tax using the information on that employee’s Form W-4.
Report Supplemental Pay on a Separate Check or as a Separate Item
Do you pay supplemental wages on a separate check or identify them as separate wages on your employee’s regular pay stub?
Then you can do one of two things.
Withhold a flat 22% of the wages. The IRS does not allow any other percentage. Also, you can only use this if you’ve withheld income tax from the employee’s regular wages in the current or previous calendar year.
Combine the supplemental pay with regular wages. You must use this method if you have not withheld income tax from the employee’s regular wages in the current or previous calendar year.
Here’s what you do:
First, combine the supplemental wages with your employee’s regular wages. If there are no regular wages in the current pay period, combine them with the total regular wages on the previous payroll period.
Then, use the employee’s Form W-4 to calculate how much to withhold from this combined amount. We’ll refer to this number as your combined withholding amount.
Figure out the regular wage withholding amount, which is:
- How much you will withhold in taxes from the regular wages in the current pay period, OR
- How much you already withheld during the most recent pay period that only had regular wages
Subtract the regular wage withholding amount from the combined withholding amount.
Finally, take the resulting number and withhold it from the employee’s supplemental income.
Phew! Are you still with me?
This option is complicated, obviously, but you only have to use it if you didn’t withhold taxes from an employee in the current or previous year.
Otherwise, you can just use the 22% deduction.
You can see the official instructions for supplemental wages on the IRS website.
Report Supplemental Pay Over $1 Million
If an employee makes $1 million or more in supplemental wages during a year, you’ll need to withhold the excess at a 37% tax rate. Or, if the tax rate for that year happens to be higher than 37%, you’d pay the higher rate.
If you’re unsure how your supplemental pay should be reported and taxed, contact your tax professional for help. It’s important to get the details right so you can avoid fines and other penalties from the IRS.