If you’ve heard the term “supplemental pay” and think it’s a non-standard type of payment offered in special circumstances (and that it doesn’t apply to your company), think again.
If your company offers bonuses, severance packages, or equity, then your company deals in supplemental pay — and you should make the most of it in the “year of the performance bonus.”* You also want to ensure that you avoid any tax liability for supplemental wages, which fall under different tax classifications.
That’s a lot to think of, but there’s no need to panic. In this quick guide, we’ll walk you through what supplemental pay is, why it matters to companies of all sizes, and some examples of what does — and doesn’t — qualify as supplemental pay.
What is supplemental pay?
Supplemental pay is monetary compensation given to the employee in addition to their regular base salary. You’ll often hear it referred to as supplemental wages, and it includes overtime pay, incentive pay, bonuses, accumulated sick pay, or anything paid in addition to someone’s regular earnings. However, health coverage and other employee benefits don’t qualify as supplemental wages because they are a type of non-wage compensation.
Keep in mind that supplemental wages are taxable income, and companies are responsible for tracking and accurately reporting supplemental pay, withholding the appropriate amount of federal income tax from an employee’s supplemental wages. In the US, for example, supplemental wages are subject to FICA (Federal Insurance Contributions Act) taxes, which means employers are required to withhold Social Security and Medicare contributions, as well as federal unemployment tax.
How do supplemental wages differ from regular wages?
Depending on the country of employment, supplemental wages may be taxed differently than regular income. The rules for withholding taxes from supplemental wages typically depend on how much money an employee receives in supplemental wages a year, and whether they are combined with regular wages or kept separate from their regular wages.
Let’s consider a company in the United States. If you pay your people a bonus in a separate bonus check, the IRS will require you to withhold federal income tax at a flat rate of 22% for supplemental wages up to US$1 million. But suppose you pay out the bonus as part of a lump sum (one sum of supplemental and regular wages) within the same check and don’t specify that it’s bonus pay. In that case, you’ll calculate tax withholding based on the withholding allowance the employee marked in their form W-4. Although this may push an employee’s earnings into a new tax bracket, it doesn’t mean the bonus is taxed differently.
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Why is supplemental pay important?
“Especially for startups, supplemental pay is a way to incentivize employees to continue on with the company. Retention can be difficult for these newer companies as they seek to garner part of the market. They may not be able to offer the best wages, but they can supplement it with bonuses and other compensation.”
— Jerry Han, CMO of PrizeRebel
Supplemental wages help companies attract, retain, and reward new and current employees without relying on their regular pay and salary increases alone to motivate them.
And one of the most important things your company can do around supplemental wages? Discuss it with your people. Even if your employees have that information in their contracts, it’s important to have conversations to ensure they understand how supplemental income works in your organization. You can start this conversation and gather their thoughts on your company’s supplemental pay offers via an employee survey or during one-on-one meetings between managers and reports.
💡 How do you take action on your survey results? Check out our playbook on creating an employee survey results action plan.
What qualifies as supplemental pay?
Supplemental wages can come in a broad array of types of compensation, and it’s up to a company’s leadership and compensation planning personnel to map out what their supplemental pay scheme will look like.
According to the IRS, supplemental pay qualifies, in the United States, as:
Overtime pay is money, in wages, earned by an employee who works any time beyond a 40-hour workweek. This applies in particular to employees paid in hourly wages rather than a salary; per the FLSA (Fair Labor Standards Act), employers are required to pay employees 1.5x the regular rate of pay for every hour worked over 40 hours.
Accumulated sick leave
Companies that offer paid sick leave for employees may elect to pay out any unused sick leave in the form of supplemental wages. The FMLA (Family Medical Leave Act) doesn’t require paid sick time at the federal level, and whether a company has to pay out sick leave depends on the company and the state laws.
When a person leaves their position at termination, they may be entitled to severance pay if the employee and employer have agreed to it in the employment contract.
Organizations often provide this to make the transition out of employment easier and avoid any bad will between the company and the former employee. Severance compensation can be paid out in a single payment or dispersed in checks over a period of time, depending on how the company has structured its severance package.
Retroactive pay increases
A retroactive pay increase is a payment to an employee to make up for the difference between the amount they received in a past pay period and how much they were owed. This can happen when a worker gets a raise at the end of the pay period, and it won’t be reflected in their check until the next pay period.
Bonuses are supplemental wage payments offered to employees as a motivating incentive or as a performance reward. Bonuses are a common part of a company’s retention strategy, and common types of bonuses include signing, referral, and retention bonuses. It’s up to each company whether to issue bonuses in cash or stock options.
Equity pay (pay in the form of company stock options) is a go-to supplemental pay strategy for new and growing companies — including those that can’t be as competitive with their base pay or other taxable fringe benefits. When offering bonuses in the form of stock options, a company asks people to bet on their future success; this sometimes pays off, but not always.
If you want to know how your people are feeling about your current salary structures, supplemental pay packages, and company overall, the employee Net Promoter Score (eNPS) is a metric that’s simple to introduce and work with.
What doesn’t qualify as supplemental pay?
Benefits like stipends, vacation pay, and paid time off don’t qualify as supplemental income. In the case of vacation pay and PTO, they are subject to the same withheld income tax as regular pay.
- Stipends: fixed sums of money paid to employees for specific purposes — like travel, child care, or nondeductible moving expenses. A stipend isn’t considered supplemental pay because it’s not paid in exchange for work; the goal is usually to offset certain expenses employees already have.
- Vacation pay: Vacation pay doesn’t qualify as supplemental pay because it’s technically part of an employee’s regular income, even though they receive it when they’re not working.
- Paid time off (PTO): Paid time off is compensation paid for any time away from work, including sick days and personal days. Just like vacation pay, it doesn’t qualify as supplemental pay because it’s counted as part of an employee’s basic income.
💡 It’s okay to have discussions about pay based on the results of an employee performance review.
In fact, a great opportunity to open a discussion about your company’s supplemental pay options with employees is during the performance review compensation discussion.
Reward & compensate your employees with Leapsome
If you offer regular and supplemental wages to employees, you’re already on the right track to ensuring they feel rewarded and motivated. You’re also showing that compensating them fairly and according to your compensation philosophy and company values matters to your business.
But these processes can overwhelm anyone, so you should have tools to help you track and monitor your employee compensation and check in to see how employees are feeling about it. And with Leapsome, you can do both on the same platform!
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