Federal income tax calculations for supplemental (or one-time) payments

How is federal income tax calculated for supplemental (or one-time) payments?

If your workers are confused by the amount of federal income tax being withheld from their paychecks, they are not alone, especially with taxes on supplemental or “one-time” payments such as bonuses, commissions, tips, etc.

The IRS defines the tax rules for these wages in the supplemental wage section of the IRS Publication 15 Circular E (https://www.irs.gov/pub/irs-pdf/p15.pdf). This section defines two allowable methods for calculating federal income tax on supplemental wages:

1. Withhold at a flat rate of 22%
2. Aggregate (or combine) the supplemental wage with the wages from the current or previous pay period, calculate the tax for the aggregated amount, and then subtract out the tax withheld during the pay period. The remainder is the tax to be withheld from the supplemental wage.

You may wonder: “Which of these options is right for my employees?” The answer depends on multiple factors, including the supplemental wage amount, W4 elections and pay history.  At Everee, we’ve taken the guesswork out of choosing by adding a third option called “Optimized”:

1. Optimized calculates tax for the supplemental wage using the flat tax method, as well as the aggregated method (if the employee has a completed current or previous regular pay period), and will choose the lower of the two tax rates. 

Everee recommends selecting “Optimized” because it does the work of finding the lowest tax withholding for you. However, as a payroll administrator you have the option to select any of these three options depending on the desired tax withholding outcome for your employees.  

Please refer to IRS Publication 15 Circular E for more information about supplemental wage tax calculations to determine which method is right for you.

Answers to frequently asked questions you can share with your employees:

Question: I am a new employee or my company just transitioned to Everee. What should I expect my tax rate to be on my one-time payments? And why is the tax rate different on payments that are paid during the first pay cycle vs. subsequent payments?

Answer: The aggregation tax method works by combining the supplemental wages with the wages earned during the current or previous pay period. So your first few payments will likely have a slightly lower tax rate than subsequent payments because there are limited payments to use in the aggregation tax rate calculation. As you get into your second pay cycle you will begin to see your tax rate reflect your annual long term tax liability.

Question: Why is my tax rate different now than it was before?

Answer: Everee is constantly evolving our platform to provide the best possible experience.  We recently released the “Optimized” tax model and updated our “Aggregation” model to use all wages from the pay period vs. only one previous payment. We introduced these changes to the Everee tax calculation engine in February 2022, so tax rates for supplemental wages calculated prior to this change may differ from those calculated afterward. However, the tax rates calculated after the change should be more representative of your annual tax liability. If you want, you can adjust your withholding elections at any time by modifying your W4 form, which is located in the tax section of your Everee profile.

Question: What can I do if I want to adjust the level of federal income tax being withheld from my payment?

Answer: You can adjust your withholding elections at any time by modifying your W4 form, which is located in the tax section of your Everee profile.