Supplemental income tax explained

At a Glance:

Supplemental income is generally money you earn outside of your regular payroll paycheck. Examples include passive rental income, employee bonuses, extra commissions, or in a broad sense even side income. Each type of supplemental income is subject to different tax treatments.

 

As an employee, taxes for most of your wages are taxed the same way based on your W-4 tax withholding. But what about employee benefits like bonuses, commissions, and other types of income? And what if you make money in other ways such as through real estate or trust? In short, the taxation is different. 

While income from real estate, trusts, and other types of income fall into an IRS designation called supplemental income, the other examples aren’t technically “supplemental income,” but things like bonuses, commissions, and even freelance income is sometimes called supplemental income in everyday language.

Read on as we outline various types of supplemental income — as defined by the IRS or otherwise — and how they are taxed.

What is supplemental income?

While we defined supplemental income in basic terms above, it’s easier to understand the concept if we break it down with actual examples. Supplemental income falls into a few categories:

1. Supplemental income (Schedule E income for supplemental income and loss)

generating supplemental income

This includes income generated from:

  • Business (Partnerships and S corporations)
  • Estates, trusts, and royalties
  • Rental real estate and residual interests in real estate mortgage investment conduits (REMICs)

2. Supplemental income for employees

If you’re a traditional employee, you could get income outside of your normal paycheck that you consider supplemental income. The IRS considers these supplemental wages. Supplemental employee wages are wage payments that aren’t regular pay. This could include:

  • Bonuses: If you earn extra money from your employer – during the holidays or as a result of a company’s or your own success, you might get a bonus. Learn more about bonus tax rates.
  • Commissions: Some employers pay a portion of total sale to the employee who made the sale. These funds are called commissions. For example, salespeople commonly earn merit-based commission as supplemental income.
  • Expense reimbursements: Fringe benefits like expense reimbursement is considered supplemental income. For example, if you incur some costs as a work-from-home employee for your internet or cell phone, your employer may reimburse you for those expenses.
  • Overtime pay: When you work beyond your normal number of hours per week as a non-exempt employee, you could get overtime pay, which can be considered supplemental wages.
  • Accumulation of Paid Time Off (PTO): If your employer pays out for unused PTO, you may receive additional wages.
  • Retroactive pay increases / Back pay / Severance pay: If your wage changes over time, it may count as supplementary income.
  • Prizes and award winnings: If you win a special award or distinction from your employer or a professional association that comes with a monetary incentive.
  • Payments for non-deductible moving expenses: If you move for a job, your employer may reimburse you for the non-deductible expenses.
  • Tips: Service-industry professionals could earn extra tips from customers, which are considered supplemental pay.
  • Taxable fringe benefits: Discretionary bonuses (including gift cards), income from exercise of nonstatutory stock options, taxable income from issuance or vesting of restricted stock, employer-provided cell phone (non-business use) and gym memberships qualify as supplemental employee income.

3. Independent contracting or side job supplemental income:

If you’re working a side hustle, you may think of this as supplemental wages. Jobs like driving for a ridesharing service, selling on an e-commerce site, or direct sales gigs are all examples of what the IRS and internal revenue code considers independent contractor work.

How is supplemental income taxed?

Supplemental tax rates depend on how you receive the income.

1. How Schedule E supplemental income taxes work

If the income source is estates, trusts, rental real estate, royalties, residual interests in real estate mortgage investment conduits (REMICs), and business (Partnerships and S corporations), then…

Estates and trusts:

Estates and trusts are two legal structures used to transfer assets. For estates and trusts, you file Form 1041 and Schedule K-1 (Form 1041). Beneficiaries pay tax on the income of the estate or trust they receive at their individual rates for ordinary income and at capital gains rates for any capital gains they receive. Additionally, if the estate or trust does not distribute all the income to the beneficiaries it will pay tax on any undistributed income.

Royalties:

Royalties are amounts paid for the use of an intangible asset. For example, if you own the copyright for a song, you will receive royalties from those that use that song by others. You will receive a Form 1099-MISC that tells you the amount of royalties to report on Schedule E. Royalties are taxed at your personal income tax rate.

Business income from S Corporations or Partnerships:

S Corporations and Partnerships are two types of business entities. Instead of the IRS taxing the entities directly the taxes “pass through” to either the shareholders (for S Corporations) or the partners (for Partnerships) personal income. The owners and partners will put their share of the income on Schedule E.  Because personal income rates will vary so will how this supplemental income is taxed. S corporations also pay wages to shareholders who provide services, and those wages are taxed at personal income rates.

Are you a small business owner? Get help filing small business taxes from Block Advisors.

Rental real estate:

Rental real estate is popular these days – and can be a great source of additional income for individuals. If you rent out a home, apartment or other property, you have real estate income. For this type of supplemental income, the tax rate ranges from 10 to 37%.

Because rental income is passive rather than active in most cases, you aren’t considered self-employed in the eyes of the IRS. Thus, you generally don’t have to pay self-employment tax on the income.

Learn more about rental real estate taxes.

Schedule E (Supplemental Income and Loss) records income and expenses from real estate activities. You receive income from rental activities mainly for the use of a tangible property (a rental property, for example), rather than for services.

2. How taxes for supplemental income for employees work

So, how are bonuses, commissions, tips, and the other examples of supplemental wages taxed? The amount of tax you pay on supplemental employee income will be based on your personal income tax rate, but the amount withheld from the income varies. Generally, it depends on how your employer pays it out… either combined with your regular wages or separate. If the amounts are combined with your regular wages the amount withheld will generally be the same as your wages.

If paid out separately, employers can withhold income tax on the payment at a flat rate of 22%.

For amounts that exceed $1 million, the taxation is a bit different. In this case, the supplemental tax rate is 37% no matter how they are paid.

What is the supplemental tax rate?

If you earn money outside of a W-2 job as a side hustle, you’re considered an independent contractor. This is true even if you didn’t formally create a business. Depending on your job type, you may receive a 1099-K or a 1099-NEC. You’ll need to report information from these forms on your individual tax return on a Schedule C (Form 1040).

Learn more about filing taxes as an independent contractor.

Get help navigating supplementary state and federal income taxes from H&R Block

Taxation rules and instructions change periodically, so it’s important to stay informed of supplementary income tax changes. Don’t have the time or desire to keep up to date?

We’re here for you. You can rely on H&R Block whether you file taxes online, or with an H&R Block tax pro.

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