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In Revenue Ruling 2008-29, the IRS has provided specific guidance on the proper amount of federal income tax an employer should withhold in the following nine different situations under the supplemental wage regulations that became effective January 1, 2007:

  • Commissions paid at fixed intervals with no regular wages paid to the employee;
  • Commissions paid at fixed intervals in addition to regular wages paid at different intervals;
  • Draws paid in connection with commissions;
  • Commissions paid to the employee only when the accumulated commission credit of the employee reaches a specific numerical threshold;
  • A signing bonus paid prior to the commencement of employment;
  • Severance pay paid after the termination of employment;
  • Lump sum payments of accumulated annual leave paid at termination of employment;
  • Sick pay paid at a different rate than regular pay

For each of the situations above, the IRS makes certain assumptions that should be reviewed when an employer has one of these situations arise. Additionally, there are carve out rules under the Revenue Ruling when more than $1 million of supplemental wages are paid during any calendar year that cause the withholding rate to differ than the rate identified here.

Regular Wages

Whether an employer is paying “regular wages” or “supplemental wages” has an impact on the amount of income taxes that should be withheld. Regular wages means wages paid by an employer for a payroll period either at a regular hourly rate or in a predetermined fixed amount. The amount that is to be withheld in the case of regular wages is based on the tax table for the pay period (e.g., bi-weekly) and the number of exemptions claimed on the employee’s IRS Form W-4.

Supplemental Wages

Supplemental wages are all wages that are not regular wages. Stated differently, supplemental wages are wages that vary from payroll period to payroll period based on factors other than the amount of time worked. Examples of supplemental wages are overtime pay, bonuses, back pay, commissions, wages paid under reimbursement or other expense allowance arrangements, nonqualified deferred compensation, noncash fringe benefits, sick pay paid by a third party as an agent of the employer, amounts includible in gross income under IRC section 409A, income recognized on the exercise of a non-statutory stock option, and imputed income for health coverage for a nondependent.

If supplemental wages are less than $1 million, the employer may generally choose to use either:

  1. the optional (25 percent) flat rate; or
  2. the aggregate method.


The optional 25 percent flat rate method may not be used, however, unless income tax has been withheld from the employee’s regular wages during the calendar year of the payment of the supplemental wages or the preceding calendar year, and the supplemental wages are separately stated from regular wages (in addition to being less than $1 million).

If all the requirements for the optional 25 percent flat rate method are not met, then the aggregate method must be used. To calculate the aggregate method, supplemental wages are added to regular wages for the most recent payroll period this year as if they were a single payment. The tax is then determined on the single payment based on the tax tables for the appropriate payroll period and using the employee’s IRS Form W-4. The tax already withheld from the regular wages is then subtracted, and the remaining tax is subtracted from the supplemental wages. The IRS has advised that when there are no regular wages, supplemental wages must be paid using the aggregate method and the tax tables should be used. This is common, for example, when back pay is paid to a former employee in settlement of litigation.

Typically, states with income taxes default to following federal regulation principles for distinguishing between regular and supplemental wages. In addition to federal income tax withholdings, states also look for proper withholding on supplemental wages for state income tax purposes.

Brian Eagan

Brian Eagan specializes in providing high level interim CFO and Controller work for small to medium size businesses, including non-profit and local government agencies. In this role, Brian makes himself highly accessible to clients by phone and e-mail, in addition to appreciating the importance of performing some of these services onsite at clients’ offices.