Supplemental Wages and Withholding
Supplemental wages are compensation paid in addition to an employee's regular wages. Supplemental wages include vacation pay, bonuses, overtime, moving expenses, sick pay, severance pay, taxable fringe benefits, and commissions.
The federal income tax on supplemental wages may be calculated two different ways, depending on how the wages are paid. If the supplemental wages are paid in the same paycheck as regular pay, the income tax is calculated the same way as regular pay. If the supplemental wages are paid separately, they may be taxed at the IRS flat supplemental rate. This supplemental rate is currently (2010) 25 percent.
The IRS specifies that supplemental withholding may be used only if the employer has withheld income taxes from regular wages and the supplemental wages are not paid at the same time as regular wages, or if the supplemental wages are separately stated on the employer's payroll records. If these conditions are met, the employer may withhold at either the regular employee-designated rate or the supplemental rate.
For example, vacation pay is usually paid along with regular pay. In this case, it should be taxed at the regular withholding rate, as determined by the employee's Form W-4. In the case of a bonus or severance pay which is paid separately, it may be taxed at the supplemental rate.
A reminder: Employers must have a W-4 form for each employee to determine the amount of withholding of federal income tax from that employee's pay. If your state has income tax, a state W-4 should also be completed by each employee. Both forms should be completed at hire. The federal W-4 may be changed at any time by the employee.
More on forms for new hires.
IRS source: Flat Rate Supplemental Wage Withholding (PDF)