Tax withholding can get tricky for your Payroll pros, between federal and state obligations.
And in addition to tax withholding on regular employee wages, there are entirely separate guidelines for supplemental wages.
This can get particularly complicated if you have employees at your company that receive more than one kind of supplemental wage payment, such as:
- retroactive pay increases
- unpaid overtime from a previous pay period
- prizes and awards (fringe benefits)
- accumulated leave payouts, and
- severance pay.
But IRS allows more than one withholding method for supplemental wages, so it’s key your Payroll pros are using the one that fits best.
2 ways to withhold on supplemental wages
The most common type of withholding for supplemental wages is the aggregate method, where supplemental wages are totaled and added to regular wages in payroll (subtracting any withholding deductions that may have already been made). Then, the withholding amount is based on whatever info the employee entered on their Form W-4.
But in the Premier Leaning Solutions online workshop “Payroll Taxes 101: Withholding, Depositing & Reporting Requirements,” Vicki Lambert, CPP, pointed out that there’s also an alternate method.
Instead of using the W-4 to compute the withholding amount, you use threshold percentages: 22% for supplemental wages up to $1 million in a calendar year or 37% for supplemental wages over $1 million.
So for example, if a sales rep earns a $1,000 commission, you’d multiply that by 0.22 to arrive at a figure of $220 to withhold.
When would it be best to use this method? Lambert explained that the alternate method comes in handy if you’re issuing a separate check – for example, a non-payday bonus check or a one-time payment for overtime that was accidentally unrecorded. This approach can help Payroll steer clear of altering your company’s pay period processing frequency (e.g., a 27th paycheck when employees are paid during 26 biweekly periods) and incorrectly calculating tax withholding.
If you’re comfortable with both methods, Lambert said you can ask employees if they have a withholding preference. But if for some reason you ever find out an employee’s supplemental wages haven’t had any federal income tax taken out in the current year, you’re required to use the aggregate method, she said.
Vacation pay withholding
Normally regarded as a regular wage payment, vacation pay may be treated as supplemental wages if it’s paid separately in addition to an employee’s regular wages, according to Lambert.
“If I were getting my paycheck today, and then I’m (going on) two weeks’ vacation … I’m not going to be here next payday (in a biweekly pay cycle). I can treat (regular wages and vacation pay) as two separate checks. I don’t have to aggregate them,” she said.
State income tax withholding
In addition to federal income tax, you may have to withhold for your state government. Forty-one of the 50 states collect income tax.
However, not all states are as flexible with supplemental wage withholding methods as the IRS. Some require that you use the aggregate method only.
If your state allows the alternate method, its percentage rate is likely different from the federal rate. So if you’re going to go down that road, you’ll want to check with your state Dept. of Labor to find out the specific percentage rates.
Tax withholding & nonresident aliens
Nonresident aliens (NRA) working in America on a visa are generally not tax-exempt on U.S.-sourced income. However, if they’re from one of the 30 countries the U.S. has a tax treaty with, they can possibly claim an exemption using IRS Form 8233, “Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual.”
If you have someone on staff with a student visa F, J, M or Q, they may be either exempt from withholding or subject to a withholding rate of 14% because they’re full-time students and not full-time workers.
Unless these individuals are filing Form 8233, it’s vital to have a W-4 on file with “NRA” indicated on the form. On the pre-2020 W-4, NRA status should be written/typed on the electronic version on line 6, or under step 4(c) if you’re using the current W-4.
Also, regardless of their marital status, NRAs can only declare as single.
Depending on which W-4 form is used, you’ll need to refer to various tax tables, charts and worksheets in Form 15-T for guidance on withholding for NRAs.
“You’re just simply going to add the amount, based on the payroll, to the employee’s wages, tax it and then take it off,” Lambert said.
Some other important notes regarding NRA employees:
- Withholding shouldn’t be reported on Form W-2.
- These procedures only apply to federal income tax, and not FICA or FUTA taxes.
- These procedures shouldn’t be used for students or apprentices from India, as they have different tax charts and guidelines to follow.
- Most NRAs should complete step 2 in the current W-4 form. Only NRAs from Canada, India, Mexico or South Korea should complete step 3.