HR Support on Employee Vacation Pay

Editor's Note: When is vacation pay supplemental wages and/or reported as a special wage payment?

Rena PirsosOverview: Payments made to employees while they are on vacation are subject to federal income (FIT) and FICA (Social Security and Medicare) tax withholding and federal unemployment (FUTA) tax as if they were regular wages. However, vacation pay paid in addition to employees' regular wages is treated as supplemental wages. This includes bonuses paid to employees who work through their vacations, lump sum payments to employees of their accumulated leave paid on termination, and annual payments to employees of their unused vacation time.

Vacation pay paid to employees from a fund established under a union agreement is subject to income tax withholding by the union when employees take vacation. The employer is required to withhold and pay FICA and FUTA on these payments.

Supplemental wages. Employers must keep track of employees' supplemental wages because different income tax withholding rules apply depending on the total amount of employees receive in a year, i.e., $1 million or less or over $1 million. Employers should also check the law of the states in which they pay employees. Many states allow flat rate withholding from supplemental wages at rates that vary widely, while other states require supplemental wages to be aggregated. A handful of states do not provide a supplemental wage tax rate at all.

Special wage payments. Payments to current or former employees of accrued but unused vacation pay may also be considered special wage payments (SWPs) if the amounts were earned in one year but paid in a subsequent year. Employers need to notify the Social Security Administration (SSA) about SWPs because of the effect they have on Social Security benefits received by those under age 65. For these individuals, when SWPs are included in earned income, the amount of their monthly benefits is reduced. SWPs must generally be reported by employers on Form W-2, Wage and Tax Statement, in the year they are received by the employee. Employers also must report to the SSA any SWPs made in a year to fully retired employees and employees who are collecting Social Security benefits but are still working. Reports are not required for employees under age 62. Reports must be filed with the SSA by April 1.

Author: Rena Pirsos, JD, Legal Editor

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