The IRS rules define two different tax brackets for supplemental wages that employers need to consider: Supplemental wages above $1 million When an employee receives supplemental wages of over $1 million in one calendar year, the tax rate applied is 37%. For the excess amount of reimbursements to the employee beyond $1 million, withholding is at 37%. This rate applies regardless of the employee’s Form W-4 (federal income tax withholding). To properly calculate an employee’s supplemental income, the employer needs to consider supplemental wages paid by all entities that are under common control, i.e., all businesses treated as a single employer. Supplemental wages below or equal to $1 million In the second scenario, when supplemental income is below $1 million per calendar year, two main methods apply: Percentage method—when you apply a flat rate to supplemental income Aggregate method—when you combine supplemental and regular wages However, in addition to this broad distinction, the IRS gives a set of steps for a couple of specific scenarios, so let’s have a look at each of them. Supplemental income is combined with regular pay If you combine employees’ supplemental income and regular wages without clearly stating the amount of each, then you should withhold federal income tax, whereby the total amount of these two types of wages is considered a single payment for a regular pay period. Supplemental income is identified separately from regular wages If you pay supplemental wages separately from regular income, or pay them together but while specifying the amount of each, then working out the tax liability gets a bit more complicated. If you’ve already withheld income tax from regular wages in the ongoing or previous calendar year, you can apply a flat rate of 22% If you’re paying out regular income at the same time as the supplemental pay, withhold federal income tax as if the total amount was a single payment for a regular pay period If you want to pay out the supplemental wages to your employee but there are no concurrently paid regular wages, add the supplemental wages to either the regular wages for the current or previous pay period If you’re planning to pay more than one type of supplemental wage during a single payroll period, aggregate all the supplemental wages for that period together with regular income, calculate the amount of taxes due for the total figure, subtract the amount of tax already withheld for both the regular wages and supplemental wages, and withhold the remaining tax No matter which method you use to withhold the federal income tax, they are subject to social security, Medicare taxes, and FUTA taxes, which you also need to take care of. Each state can prescribe its own set of supplemental tax rates paid to the amount of supplemental wages, which can vary based on the type of supplemental income. For instance, in California, the tax rate applied on supplemental pay is 6.60%, but in the case of stock options and bonuses, it is 10.23%.