What is supplemental pay? Definition, importance & what it isn’t

2022 was the year of the employee — but in 2023 and 2024, things took a sharp turn. Employee reign came to a halt with a looming recession, budget cuts, and widespread layoffs. 

As companies grapple with this scenario, they’re also dealing with a severe talent shortage and looking for ways to retain existing team members. Salary, of course, is still an essential part of the package.

If your company offers bonuses, severance packages, or equity, you deal in supplemental wages (and should make the most of it). You also want to avoid any tax liability for supplemental wages, which fall under different tax classifications. 

That’s a lot to think about, but there’s no need to panic. In this quick guide, we’ll walk you through what is considered a supplemental wage, why it matters to companies of all sizes, and some examples of what does — and doesn’t — qualify as supplemental pay.
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What’s the meaning of supplemental income?

Supplemental pay is monetary compensation that an employer gives an employee in addition to their 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 in addition to someone’s regular earnings. However, note that health coverage and other employee benefits aren’t forms of supplemental wages, qualifying as non-wage compensation.

Keep in mind that supplemental wages are taxable income, and companies are responsible for tracking and reporting supplemental pay, withholding the appropriate amount of federal income tax from an employee’s supplemental wages. In the United States, supplemental wages are subject to Federal Insurance Contributions Act (FICA) taxes, which means employers are required to withhold Social Security and Medicare contributions, as well as federal unemployment tax.

So, what does supplement income mean? Essentially, the term refers to any additional earnings outside of an employee’s regular salary, which are classified as supplemental income. To define supplemental income, it’s crucial to understand its various components and their tax implications. Understanding the meaning of supplemental income can help businesses manage their payroll more effectively.
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Supplemental wages vs. regular wages

Depending on the country of employment, supplemental earnings 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.

Let’s consider a company in the United States. Suppose you pay team members a bonus in a separate check. In that case, the Internal Revenue Service (IRS) will require you to withhold federal income tax at a flat rate of 22% for supplemental wages up to US$1 million. 

But let’s say you pay out the bonus as one sum of supplemental and regular wages within the same check, without specifying that it’s bonus pay. In that case, you’ll calculate tax withholding based on the employee's withholding allowance marked in their W-4 form. 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?

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. 

One of the most beneficial things companies can do regarding supplemental pay is discuss it openly with team members. Even if employees have that information in their contracts, it’s important to have conversations to ensure they understand how supplemental income works in your organization. 

Start these discussions and gather people’s thoughts on your company’s current approach to compensation management by running an employee survey or during one-on-one meetings between managers and reports. 

💡 Wondering how to take action on survey results? Read our guide on creating an employee survey results action plan.

What qualifies as supplemental pay?

Supplemental wages can come in many different types of remuneration, 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, the following qualifies as supplemental pay in the United States:
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Overtime pay

Overtime pay is money, in wages, earned by an employee who works any time beyond a 40-hour workweek. This applies, in particular, to team members who receive hourly wages instead of a fixed salary. As per the Fair Labor Standards Act (FLSA), US employers must pay employees 1.5x the regular pay rate for every hour worked over 40 hours.
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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 Family Medical Leave Act (FMLA) doesn’t require paid sick time at the federal level, and whether an organization has to pay out sick leave depends on the company and state laws.
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Severance pay

When a person leaves their position due to termination, they may be entitled to severance pay if the employee and employer agreed to it in their employment contract — and, as always, demanding on local laws. 

Organizations often provide severance pay to ease the transition out of employment and avoid any bad will between the company and the former employee. Depending on how the organization structures its severance package, severance compensation can be paid out in a single payment or dispersed in checks over a specific period.
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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, which won’t be reflected in their paycheck until the next pay period.
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Bonuses

Bonuses are supplemental wage payments offered to employees as motivating incentives or performance rewards. They are often part of a company’s retention strategy, and common types include signing, referral, and retention bonuses. Some organizations issue bonuses in cash, whereas others offer different formats (like stock options).
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Equity pay

Equity pay (pay in the form of company stock options) is a go-to supplemental pay strategy for new and growing businesses — especially 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 team members feel about your organization’s current salary structures, supplemental pay packages, and overall position, the employee Net Promoter Score (eNPS) is an effective metric that’s simple to introduce and work with.
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What doesn’t qualify as supplemental pay?

Benefits like stipends, vacation pay, and paid time off (PTO) don’t qualify as supplemental income. Vacation pay and PTO are subject to the same income tax withholding as regular pay.

• Stipends: Fixed sums of money paid to employees for specific purposes — like travel, childcare, 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 expenses people already have. ‍
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• 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.‍
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• PTO: Paid time off is compensation 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 primary income.

Variable compensation, such as bonuses or incentive pay, is considered supplemental income because it is provided based on performance or meeting specific targets.

💡 It’s okay to have salary reviews based on employee performance results!

In fact, performance review compensation discussions are great opportunities to discuss your company’s supplemental pay offerings with team members.
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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. 

Having a regular compensation review process makes team members feel secure and gives them something to work toward. With Leapsome Compensation, you can implement salary benchmarking with Mercer data to keep your compensation competitive and aligned with industry standards — further boosting employee satisfaction and retention.

These processes can overwhelm anyone, so be sure to have tools to help you track employee compensation conversations and see how team members are feeling. And with Leapsome, you can do both on the same platform!

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