Similar to the federal supplemental income tax withholding rate, most states allow for an optional flat percentage of income tax withholding for wages that are in addition to regular pay. When allowed, the supplemental rate greatly simplifies income tax withholding calculations on irregular payments such as bonuses, equity compensation and separation pay.

In light of the Tax Cuts and Jobs Act (TCJA) enacted on December 22, 2017, some uncertainty will initially exist for 2018 supplemental income tax withholding in some states. That is because states may already be coupled with the Internal Revenue Code (IRC) or may go that direction in the near future, affecting not only tax rates but the matter of the personal allowance deduction suspended through 2025 under the TCJA. Already several states have announced that their 2018 income tax withholding tables will be delayed due to this issue (e.g., Oregon and Vermont).

The enactment of the TCJA also throws the federal supplemental withholding rate in question for supplemental wages of up to $1 million. Currently, the rate of 25% applies to supplemental wages under $1 million and this is based on using the third tax bracket as provided for under IRC Section 1(i)(2) and codified in IRS Reg. Section 31.3402(g)-1(a)(7)(iii)(F). The TCJA repeals IRC Section 1(i)(2) through December 31, 2025, which could force the IRS to raise the rate of withholding on supplemental wages of less than $1 million from 25% to 28%, rather than using the lower third bracket rate of 22% established by the TCJA. It is uncertain at this time how much leeway the IRS has in determining the rate that will apply. (For more information, see Tax Alert 2017-2216.)

The rate of withholding on wages over $1 million is not in question, which uses the highest tax bracket. Accordingly, the flat federal rate of income tax withholding for supplemental wages over $1 million will decrease from 39.6% to 37% effective January 1, 2018.

For supplemental wage payments made on and after January 1, 2018, it will be important that employers continue to use the existing 25% rate until such time as IRS guidance is issued. In anticipation of changes in the individual income tax rates that would be made by the TCJA, the IRS issued a statement indicating that the 2018 income tax withholding tables and related guidance will be issued in Notice 1036 sometime in January 2018, and employers are encouraged to implement these changes in February 2018.

The state supplemental income tax withholding rates that have thus far been released for 2018 are shown in a chart beginning on page 2 of the attached PDF. States where the 2018 rate is pending due to delay in the state's publication of the income tax withholding tables are noted. Where pending, the 2017 rate applies until state guidance is available.

We will update this chart in February when outstanding states have issued guidance.

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EY Payroll News Flash