The IRS has issued new proposed regulations for withholding of income
tax from supplemental wages. REG-152945-04 may be reviewed at irs.gov.
The proposed regulations provide a new definition of supplemental
wages and require withholding at a 25% rate on supplemental wages
up to $1 million, and 35% for amounts over $1 million. Issued January
5, 2005, the regulations will become effective upon issuance as final
regulations.
New Definitions
The proposed regulations would define supplemental wages as any payment
of wages not classified as regular wages. Regular wages are amounts
paid by an employer for a payroll period at a predefined rate or regular
hourly rate. Amounts that vary by payroll period and are not based
on time worked are, by default, supplemental wages. This would include
commissions, tips and bonuses when paid in addition to regular wages.
If an employee were to receive only one type of pay (i.e. commissions),
then this type pay is regular pay subject to regular rules.
As proposed, supplemental wages of $1 million or less for a taxable
year are subject to the optional flat rate method of withholding at
25%. The flat rate is used if income tax has been withheld from regular
wages for the employee and the supplemental wages are not paid concurrently
with regular wages or are separately stated on the payroll records.
Employers may also aggregate regular and supplemental wages when paid
for the same period, calculating the tax on the total of both pay
types. The withholding on the regular wages is subtracted from the
total withholding, with the difference being allocated to the supplemental
payment.
It will be mandatory to use a higher flat rate of 35% withholding
on year-to-date supplemental wages over $1 million. This will require
very specific calculations to know when the threshold is reached and
to withhold on any payment, or partial payment, in excess of $1 million.
The new regulations clarify that flat rate withholding applies on
supplemental payments even when the employee has a valid Form W-4
for exempt status. The W-4 applies only to regular wage withholding.
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