Supplemental Wages: Tax Withholding Rules for Bonuses, Commissions & Severance

8/5/2026

Every December, payroll teams field the same complaint: "My bonus was taxed at 40 percent." It wasn't. It was withheld at a flat rate that has nothing to do with the employee's actual tax liability, and the difference will settle up on the return.

Explaining that is the easy part. The hard part is that supplemental wage withholding has real rules — about which method you may use, when one becomes mandatory, and what qualifies as supplemental in the first place — and getting them wrong creates employer liability, not just an unhappy employee.

What Counts as Supplemental Wages

Supplemental wages are wages paid in addition to an employee's regular wages. Regular wages are amounts paid at a regular hourly, daily, or similar periodic rate, or a predetermined fixed amount for the current payroll period.

Common supplemental wages include:

• Bonuses, including signing and retention bonuses
• Commissions
• Overtime pay (when paid separately from regular wages for the period)
• Severance pay
• Back pay and retroactive pay increases
• Awards and prizes
• Payments for accumulated sick leave or unused PTO at termination
• Taxable fringe benefits
• Nondeductible moving expense reimbursements
• Certain expense allowances paid under a nonaccountable plan
• Reported tips, in certain circumstances

The distinction matters for income tax withholding only. Social Security, Medicare, and FUTA apply exactly the same way to supplemental wages as to regular wages. There is no separate FICA treatment.

The Two Withholding Methods

The Optional Flat-Rate Method

You may withhold federal income tax at a flat percentage without regard to the employee's Form W-4 — but only if two conditions are satisfied:

1. Income tax was withheld from the employee's regular wages in the current or preceding calendar year, and
2. The supplemental wages are paid separately from regular wages, or are separately stated in your payroll records.

[VERIFY: The optional flat rate has historically been 22%. Confirm the current-year figure in IRS Publication 15 (Circular E) before publishing — this rate is tied to statutory income tax rates and moves when those rates change.]

If no income tax was withheld from the employee's regular wages — because the W-4 produced zero withholding, for instance — the flat rate is not available. You must use the aggregate method. This is the condition payroll systems most often fail to enforce automatically.

The Mandatory Higher Rate

Once an employee's cumulative supplemental wages exceed a statutory threshold within a single calendar year, withholding on the excess is required at the highest income tax rate, regardless of the employee's W-4 and regardless of which method you use for the rest.

[VERIFY: Historically the threshold has been $1,000,000 in supplemental wages per employee per calendar year, with a mandatory rate of 37% on the excess. Confirm both figures against current IRS guidance.]

Three things about this rule catch employers out:

• It is cumulative across the calendar year, not per payment. A $600,000 bonus in March and a $600,000 payment in November cross the threshold on the second payment.
• It applies to the excess only. The portion below the threshold is withheld under whichever method you otherwise use.
• It is mandatory. There is no election, and the employee cannot opt out via Form W-4.

This is not a large-company-only issue. Executive severance, equity vesting, and change-of-control payments routinely cross the threshold at mid-sized employers during a transaction year.

The Aggregate Method

Combine the supplemental wages with the regular wages paid in the same payroll period, treat the total as a single payment, and compute withholding using the employee's Form W-4 and the applicable withholding tables. Subtract the amount already withheld on the regular wages; the remainder is withheld on the supplemental portion.

The aggregate method is required when:

• No income tax was withheld from the employee's regular wages in the current or preceding year, or
• Supplemental wages are combined with regular wages in a single payment and not separately stated.

It is also usually fairer to lower-paid employees, whose marginal rate falls below the flat rate. An employee in a low bracket receiving a bonus withheld at the flat rate is over-withheld — not overtaxed, but their money is tied up until they file.

Choosing Between Them

Bonus of $10,000 paid on a separate check
Employee had income tax withheld from regular wages this year

Flat-rate method:      $10,000 × flat rate  ? single line, simple
Aggregate method:      Combine with the period's regular wages,
                       apply W-4 and tables, subtract prior withholding

The flat-rate method wins on administrative simplicity and is what most employers use for annual bonus runs. The aggregate method produces withholding closer to actual liability and is worth using when a large payment goes to an employee whose bracket is well below the flat rate.

Employees cannot demand a specific flat rate. An employee who wants different withholding should adjust their Form W-4 — which only affects the aggregate method — or, in practice, plan for the reconciliation at filing.

Payment-Type Specifics

Bonuses

The most common supplemental payment and the most misunderstood. Two points to communicate clearly to employees: the flat rate is a withholding rate, not a tax rate, and any over-withholding is refunded on the return.

Note the wage-and-hour overlap. A nondiscretionary bonus paid to a non-exempt employee must be included in the regular rate for overtime purposes, and if it covers more than one workweek it must be allocated back with overtime recomputed. That is a separate obligation from withholding, handled in our overtime calculation guide, and it is routinely missed because the bonus is processed by a different team.

Commissions

Supplemental wages when paid separately from regular wages. Where an employee is paid solely by commission at a regular interval, those payments may be regular wages rather than supplemental — the characterization depends on the arrangement, not the label. Draws against commission are wages when paid.

Severance

Severance is wages, fully subject to income tax withholding, Social Security, Medicare, and FUTA. This has been settled since the Supreme Court's decision in Quality Stores. Structuring severance to avoid FICA does not work.

Two additional considerations: severance paid across a calendar-year boundary may fall into a year where the employee has no regular wages — which can eliminate the flat-rate option — and severance agreements involving deferred payment can implicate Section 409A. Involve counsel on the second point.

PTO and Sick Leave Payouts at Termination

Supplemental wages. Also note the state-law dimension: many states require payout of accrued, unused vacation on termination and set deadlines for the final paycheck that are far shorter than your normal cycle. Those deadlines and their penalties are state-specific.

Taxable Fringe Benefits

Personal use of a company vehicle, group-term life insurance over the excludable amount, gift cards (never de minimis, regardless of amount), and similar items are supplemental wages. Employers may elect a special accounting rule for certain benefits provided in the last months of the year. Non-cash fringe benefits still require withholding, which means grossing up or withholding from other wages.

State Supplemental Withholding

Many states set their own supplemental withholding rate, and it rarely matches the federal rate. Some states have no separate supplemental rate and require the aggregate method. Some have separate rates for bonuses versus other supplemental payments.

For multi-state employers this is a per-state payroll configuration item that needs an annual review — see our Multi-State Taxation resources. [VERIFY current state rates before publishing.]

Reporting

Supplemental wages are not reported separately on Form W-2. They are included in Box 1 (wages, tips, other compensation) and, subject to the applicable wage bases, in Boxes 3 and 5, with the withholding included in Box 2. There is no supplemental-wage box.

The one recordkeeping requirement that does matter: if you use the flat-rate method on the basis that supplemental wages were separately stated, your payroll records must actually show that separation. Our Payroll Reporting Requirements guide covers the documentation standard.

The Five Errors Worth Auditing For

1. Using the flat rate when no income tax was withheld from regular wages. The condition is rarely enforced in payroll configuration.
2. Missing the cumulative mandatory-rate threshold. Systems often evaluate per payment rather than per employee per year.
3. Treating severance as non-wages for FICA purposes.
4. Omitting non-cash fringe benefits from withholding entirely.
5. Failing to recompute overtime on nondiscretionary bonuses paid to non-exempt employees.

Frequently Asked Questions

Are bonuses taxed at a higher rate than regular pay?

No. Bonuses are withheld at a flat rate when the optional method is used, but they are taxed at the employee's ordinary rates. Over-withholding is refunded on the tax return.

When can I use the flat-rate method?

Only if income tax was withheld from the employee's regular wages in the current or preceding calendar year, and the supplemental wages are paid separately or separately stated in your records. Otherwise you must use the aggregate method.

What happens when supplemental wages exceed the annual threshold?

Withholding on the excess is mandatory at the highest income tax rate. The threshold is cumulative per employee per calendar year, and no W-4 election overrides it.

Is severance pay subject to FICA?

Yes. Severance is wages for federal income tax, Social Security, Medicare, and FUTA purposes.

Can an employee ask me to withhold a different flat rate on a bonus?

No. The flat rate is fixed by regulation. An employee wanting different withholding must adjust their Form W-4, which affects only the aggregate method.

Are supplemental wages reported separately on Form W-2?

No. They are included in Box 1 with all other wages, with withholding in Box 2. There is no separate reporting line.

The Bottom Line

Confirm the current-year rates before every bonus cycle, enforce the flat-rate eligibility condition in your payroll configuration rather than by habit, track cumulative supplemental wages per employee against the mandatory threshold, and remember that a nondiscretionary bonus to a non-exempt employee carries an overtime obligation on top of the withholding one.

For structured instruction, explore our Payroll Training Courses and Payroll Certification Programs, or review the Payroll FAQs and Glossary of Payroll Terms.