New 2018-2025 Supplemental Wage Withholding Rates

Supplemental wages include bonuses, commissions, stock option income, and other income earned outside of regular payroll amounts.  Federal income tax withholding on supplemental wages is computed under one of three methods:

1.      Mandatory flat-rate method.  When supplemental wages exceed $1 million during a calendar year, federal income tax withholding must be at the highest ordinary income tax rate.  In 2017, this rate was 39.6%.  For 2018-2025, the flat-rate drops to 37%.

2.      Optional flat-rate method.  For supplemental wages (paid separately from regular wages) of $1 million or less during a calendar year, federal income tax withholding must be at the third lowest ordinary income tax rate.  In 2017, this rate was 25%.  For 2018-2025, the flat-rate drops to 22%.

3.      Aggregation method.  For supplemental wages of $1 million or less during a calendar year, the supplemental wages can simply be added to regular wages to determine the amount of federal income withholding for that payroll period.

In addition, back-up income tax withholding is required on payments to a person that had either a missing or an incorrect taxpayer identification number on a required information return filing (e.g., Form 1099).  The back-up withholding rate must be at the fourth lowest ordinary income tax rate.  In 2017, this rate was 28%.  For 2018-2025, the flat-rate drops to 24%.

Some taxpayers with supplemental wages fall into the trap of thinking that the optional flat-rate withholding pays all of the federal income tax due on those wages.  For example, employees with nonqualified stock option income or bonus income may have had 22% in federal income tax withholdings, but much or all of those supplemental wages may be subject to higher ordinary income tax rates (e.g. 24%, 32%, 35%, or 37%).  Therefore, it is important that such individuals estimate what the total income tax will be on those supplemental wages and set aside any shortfall in order to have the cash needed to fully pay the total income tax when the tax return is due.