Since January 1, 2005, the American Jobs Creation Act of 2004 (Jobs Act) required an employee who received supplemental wages in excess of $1 million from an employer in a calendar year, to subject the excess of the supplemental wages over $1 million to mandatory withholding at the highest income-tax rate.
The Internal Revenue Service (IRS) published regulations on supplemental wage withholding that are effective for wages paid on or after January 1, 2007. The regulations discuss the classification of payments as regular or supplemental wages. Highlights of the regulations include the below.
Regular wages are amounts that are paid at a set hourly, daily, or other periodic rate for the current payroll period or at a predetermined fixed determinable amount for the current payroll period. Supplemental wages are all other wages. Compensation that does not constitute wages subject to federal income tax withholding is not included in regular or supplemental wages. For instance, income from disqualifying dispositions of stock acquired from exercising incentive stock options is not wages subject to withholding, and not included in calculating regular or supplemental wages.
The regulations provide that employers are not allowed to treat salary reduction deferrals by employees (such as deferrals of wages into 401(k) plans) as supplemental wages. Salary reduction deferrals must be allocated to the gross amounts of regular wage payments or gross amounts of supplemental wage payments from which they are deferred.
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