As a business owner, you must be well aware of payroll. Wage is one of the most significant aspects of employment. Apart from the regular wages, workers also appreciate the opportunity to earn extra income as overtime or supplemental wages.
However, for some business owners, supplemental pay is a complex topic. The issue of regular wages vs. supplemental wages can be easily sorted if you understand the definition of both pay types, the misconception about supplemental pay, and how taxation is applied to both salaries. That’s what we are going to cover in this blog.
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Regular wages vs. supplemental wages: The Definition
Regular wages refer to the typical pay workers receive for regular work hours. It is paid to a worker for the standard employment activities and is calculated based on the base salary or hourly rate agreed upon between the worker and employer. The regular pay is subject to regular income tax withholding and other payroll deductions such as Social Security.
Supplemental wages are additional payments a worker receives separate from regular wages, such as bonuses, overtime, commissions, severance, and vacation pay. These wages are not part of the workers regular salary or hourly rate and are often one-time or occasional. Furthermore, the supplemental wage is subject to different tax withholding rules.
Regular wages vs. supplemental wages: The Taxation
Regular wages are subject to federal and state income tax, Social Security tax, and Medicare tax.
The federal income tax is calculated on workers regular wages based on their filing status and withholding allowances claimed on their Form W-4. Also, the amount withheld is based on taxable income and the tax brackets applicable for the tax year.
If you are in a state with a state income tax on regular wages, you will be subjected to specific rates and rules depending on your state. Some states have a flat tax rate for regular wages, while others use progressive tax structures like the federal income tax.
Social Security tax is also called the Old Age, Survivors, and Disability Insurance (OASDI) tax which is a tax that funds Social Security benefits. The Social Security tax rate in 2023 is 6.2% on wages up to $160,200 annually. Medicare is another federal tax with a flat tax rate of 1.45% on all regular wages. There is no income threshold, and in addition to the workers contribution, the employers are also required to contribute 1.45% of the workers wages to Medicare.
Supplemental wages are also subject to federal income tax withholding, but the rules differ from the regular wages tax. There are two methods to calculate supplemental income tax:
1. Aggregate Method:
This method is used when an worker is paid regular and supplemental wages during the same payroll period. If a worker earns both wages, the employer can combine the amounts and withhold federal income tax based on the workers total taxable income for that period. The withholding tax rates will depend on the workers withholding status and the number of withholding allowances claimed.
2. Flat Rate Method:
If the employers want, they can use a flat supplemental income tax rate to calculate federal income tax. Here, the default rate is 22% for supplemental wages up to $1 million. If the supplemental wages exceed $1 million, the excess amount is taxed at a flat rate of 37%.
Employers need to consider the state income tax withholding on supplemental wages as states have rules, which may vary depending on the specific state regulations. Additionally, other local taxes or deductions can be made depending on the jurisdiction.
Regular wages vs. supplemental wages: Examples
Regular wages include your base salary, which is a fixed agreed-upon salary. It also consists of the hourly wages for contractual staff. Your annual salary is counted as regular wages irrespective of pay periods (e.g., monthly or bi-weekly).
For hospitality workers like restaurant servers, the tipped wages are also included in the regular wages as they often work below minimum wage in the expectation that customer tips will make up the difference.
Piecework wages are also regular wages, where workers are paid based on the number of units or pieces produced or completed. Allowances for reimbursements of expenses like commuting, uniforms, or job-related costs are also part of regular pay.
Any additional pay apart from the regular wages form supplemental wages, including bonuses, overtime pay to commissions, and severance pay. Your vacation pay for unused vacation days or as part of paid time off (PTO) policies is also calculated as supplemental. Non-cash or cash rewards from the employer for exceptional performance or participation in competitions are supplemental wages.
Any relocation allowances, such as reimbursements or relocation payments for work purposes, counted as additional income. Any nonqualified deferred compensation, such as payments made tostaff outside of qualified retirement plans or wages paid retroactively to staff for past work due to wage adjustments, corrections, or legal settlements, are also supplemental wages.
The examples provided are incomplete, and many more supplemental and regular wages can vary depending on the industry, job roles, and jurisdictions.
Regular wages vs. supplemental wages: Reporting requirements
There are specific reporting requirements for regular and supplemental wages.
For reporting regular wages, employers must provide workers with a Form W-2, Wage, and Tax Statement by January 31st of the following year. This form reports the staff’s wages, tips, other compensation, and taxes withheld throughout the year. The total regular wages are reported in Box 1 of Form W-2.
Supplemental wages are also reported on Form W-2. However, they can be reported in either Box 1 (total wages) or Box 3 (Social Security wages) of Form W-2. If some supplemental wages are not reported in Form W-2, they can be reported on Form 1099-MISC as Miscellaneous Income.
Importance of distinguishing between supplemental and regular wages
Identifying and differentiating between regular and supplemental wages is essential for deciding the appropriate tax withholding methods and rates.
As there are separate reporting requirements for regular wages and supplemental wages on tax forms, distinguishing between the two is necessary for accurate tax reporting.
For employers, distinguishing between regular and supplemental wages helps to comply with employment laws such as overtime regulations.
Finally, differentiating between regular and supplemental wages is essential for a company’s financial planning as it aids in budgeting.
Supplemental wages are taxed higher than regular wages:
Supplemental wages are indeed subject to different tax withholding methods and rates, but compared to regular wages, they are not taxed at a higher overall rate.
Supplemental income is tax-free:
Workers must report any supplemental income to calculate their tax liability.
For employers, it is necessary to understand the difference between regular wages and supplemental wages. As both incomes have specific tax rules and regulations applicable in their jurisdiction, both employers and worker need to understand them to ensure proper tax reporting and compliance.
Frequently Asked Questions
Are supplemental wages taxed at a higher rate than regular wages?
Supplemental wages are subjected to different tax withholding methods but are generally taxed at the same rates as regular wages. Some withholding calculation methods for supplemental wages, like the flat rate method, may seem like supplemental pay attracts a higher tax rate. Still, it’s ultimately the actual tax liability that determines the rates.
What are some examples of supplemental wages?
Commissions, bonuses, vacation pay, overtime pay, severance pay, tips, awards and prizes, and relocation allowances are supplemental wages.
Are regular wages and supplemental wages reported separately on tax forms?
Yes, regular wages and supplemental wages are taxed differently. Regular wages are reported on Form W-2, Wage, and Tax Statement, while the supplemental wages are usually reported on a separate section of Form W-2 or Form 1099-MISC.
Do I need to report my supplemental wages on my tax return?
You must report both regular and supplemental wages on your tax return. The federal and state income tax is applied to all earnings from regular and supplemental wages, so it’s mandatory to report both to reflect the total income earned.
How can employers ensure accurate tax withholding for supplemental wages?
Worker s should understand the different tax withholding methods for supplemental wages to ensure accurate tax withholding for supplemental wages. Employers should update their payroll systems to calculate and withhold supplemental wages taxes accurately. Seek professional advice to ensure compliance with tax regulations and accurate tax withholding for supplemental wages.