Supplemental wages are income earned by an employee outside of regular pay. Common examples of supplemental pay include income for bonuses, commission, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, retroactive pay increases and payments for nondeductible moving expenses.
The main purpose for designating earned income as supplemental pay versus standard income is for tax accounting. The IRS issues guidelines to employers on how to account for tax withholding on supplemental wages based on the amount earned by employees. Along with the already mentioned common types of supplemental pay, taxable fringe benefits and expense allowances paid under a nonaccountable plan are also considered supplemental, according to MissouriBusiness.net.
Over $1 Million Earned
Rules on accounting for supplemental pay when an employee earns over $1 million in supplemental income are provided in Treasury Decision 9276. In this particular situation, the employer is directed to withhold either 35 percent of earnings or a percentage equal to the highest rate of income tax for the year. If an employee works for several business entities under one corporate or parent business, all supplemental income is added together to determine whether he has met the $1 million threshold.
Less Than $1 Million Earned
Rules are slightly different when an employee earns less than $1 million in supplemental income, but withholding guidelines vary. If supplemental pay is actually combined with regular pay with no separate paycheck designated, normal withholding is applied to all earnings. When payments are separate, withholding becomes more complex. The employer can elect to withhold at a flat 25 percent flat rate or work through a more complex process to combine earnings and determine how much should be held with the addition of supplemental pay.
Companies pay supplemental wages for a variety of purposes but typically as a way to help motivate employee performance. Commissions and bonuses are often paid to sales reps and managers to incentivize high performance. Overtime pay is often mandatory when a company needs an employee to work more than 40 hours in a week. Severance pay is used to salvage a relationship when an employee is laid off. Other awards, prizes and rewards for performance are smaller types of performance incentives.