What is supplemental pay and how is it taxed?

Receiving additional pay in combination with a regular salary is a great incentive for employees, but it might give your HR department a bit of a headache to find out what qualifies as supplemental pay and what that means for the payments.

On this page, we quickly explain the concept of supplemental income, how it is different from regular wages, and how it is taxed.

Supplemental income refers to any type of payment an employee receives that is not part of their regular salary. For example, this might be a bonus for achieving performance goals, or compensation for overtime.

Employees are not entitled to supplemental pay, but it might still be part of their contract as an incentive from the employer. It is also possible that employees receive an additional pay without even being notified beforehand, e.g. as part of an end-of-year bonus.

Examples for supplemental income:

• Bonus payments

• Overtime compensation

• Accumulated and unused sick leave

• Commission and tips

• Severance pay

• Back payments

• Retroactive pay increases

• Payments for nondeductible moving expenses

• Taxable fringe benefits

• Income from winning awards or prizes

Good to know: Vacation pay does not necessarily fall into the category of supplemental pay, as it usually is part of the regular salary. However, if not all vacation time is used and is therefore paid out as a lump sum, it does qualify as supplemental income.

The main difference between supplemental pay and regular wages is how the income is taxed. While salaries are subjected to income tax, it is not quite as straightforward when it comes to supplemental payments, and rather depends on the type of payment made. Additionally, there are varying ways of compliant reporting for supplemental pay.

Another point of difference between wages and supplemental income is that wages are usually paid out following a predetermined payroll period. Supplemental pay, on the other hand, usually doesn’t follow a specific payment frequency. In most cases, it is up to the employer to decide when supplemental payments are issued out to their employees.

Finally, while it is mandatory to pay employees for their work, employers are not obligated to hand out additional payments. Some employers may choose to do so freely, while others may have a paragraph in their contracts that outlines additional payments.

Calculating the tax rates for supplemental pay is highly dependent on two things: Country-specific tax laws, as well as the amount of supplemental income. 

Generally speaking, a lot of countries allow for supplemental pay to be simply added to the regular wage, and withhold the income tax for this combined sum. However, this option might only be applicable if the additional payment has been combined with the salary in one transaction and the individual amounts are not specifically mentioned.

However, if the supplemental pay has been issued in a separate transaction, your employees might be able to apply a reduced tax rate to the additional payment. In the United States, for example, this reduced rate is currently set at 22%. 

Please note: Tax rates for supplemental pay have to be calculated according to local tax regulations and differ from country to country.

If your employees are spread out all over the world, chances are you have to comply with several different tax regulations and labor laws. This can quickly become extremely time-consuming for your HR team, and also holds a lot of room for error. 

This is where Lano’s global payroll solution comes into play: Our payroll software automates payments and allows you to plan and schedule salary transactions as well as supplemental payments. 

Learn more about Lano’s global payroll solution