Supplemental income refers to extra earnings received on top of your regular paycheck. It’s often irregular or unpredictable, which is why the IRS requires specific protocols to prevent underpayment of taxes. Here, we’ll cover the different types of supplemental pay and how the earnings are taxed.
Key takeaways about supplemental income
- People earn supplemental income in various ways, like getting bonuses, commissions, rental income, or even proceeds from investments.
- Supplemental income is generally taxed at ordinary income tax rates. However, certain types, like bonuses and commissions, may be subject to a flat federal withholding rate of 22%.
- Examples of extra income that is not subject to income tax include child support payments, gifts, inheritance, grants, scholarships, and welfare.
- Employees typically report supplemental income on their W-2, while other types like rental income or partnership earnings are reported on Schedule E.
- The One Big Beautiful Bill (OBBB) introduced potential deductions related to supplemental income, including tips and overtime pay, offering taxpayers the possibility to reduce a portion of these earnings when calculating their taxable income.
What is considered supplemental income?
You can better understand how different types of supplemental income are taxed by considering their source and your involvement in generating them. If you are an employee, your supplemental income will differ from a freelancer’s. You might earn money from renting out property, or through owning a part of a partnership or S Corporation. Each of these sources of income has its own set of rules for how you need to report it on your taxes. To clarify this, let’s look at some real-life examples of different types of supplemental income.
1. Supplemental income as an employee
If you’re a traditional employee, there are various ways to receive supplemental income apart from your regular payroll wages:
- Bonuses – An employer may offer performance-based bonuses, including holiday bonuses.
- Commissions – Commission income is in return for services performed and typically a percentage of sales made or a fixed amount per sale.
- Overtime pay – Pay for working beyond your normal business hours can now be deducted under the new provisions of the One Big Beautiful Bill (OBBB).If you earn above your regular rate (like the “half” in “time-and-a-half”) you can deduct up to $12,500 if you file as single, or $25,000 if you file jointly.
- Taxable fringe benefits – Employer-provided non-cash benefits, such as health insurance, personal use of company-owned assets, gym memberships, or even expense reimbursements (such as non-deductible moving expenses) may be considered a supplement to your regular wages.
- Retroactive pay increases or back pay – In most cases, if you receive additional income for unpaid or underpaid work, the IRS categorizes this as a supplement to your wages.
- Reported tips – If you work in a service industry or profession, tips are considered earned income and are taxed accordingly. Starting in tax year 2025 (the tax return you file in 2026), you’ll be able to deduct up to $25,000 in tip income as an above-the-line deduction.
The supplemental wages you receive as an employee are usually included in the W-2 you receive from your employer. You need to report this information when filing your tax return. IRS Publication 15 instructions provide several examples of income your employer may categorize as supplemental wages, such as severance pay, awards, prizes, payments for unused PTO, and accumulated sick leave.
2. Supplemental income reported on Schedule E
Schedule E is designed to report income or loss from certain passive activities or investments. The types of supplemental income reported on Schedule E typically involve passive participation or ownership interests in various entities or assets. Here are the types of income reported on Schedule E:
- Rental real estate and royalty income – Income earned from renting out your property (such as Airbnb or VRBO rentals) or allowing others to use your intellectual property (such as patents, copyrights, or trademarks) in exchange for payment is considered supplemental wages.
- Partnerships and S Corporations – If you share in the profits of a business with two or more owners, this income is an addition to income that gets reported on Schedule E.
- Estates and trusts – If you are the beneficiary of a trust that invests in bonds, stocks, or savings accounts, any interest earned on those investments are considered supplemental income from the trust.
- Real Estate Mortgage Investment Conduits (REMICs) – Investors in REMICs may receive income from the interest and principal payments made on the mortgages. Residual interest payments should be reported on your Schedule E as supplemental income.
3. Supplemental income for self-employed
If you have a side job, any income you earn can be considered supplementary to your regular income. For tax purposes, you are regarded as self-employed and must report the income earned from selling goods or services on Schedule C as self-employment income. While Schedule C income is subject to self-employment tax, an advantage is you can deduct business-related expenses.
How is supplemental income taxed?
Supplemental income is taxed based on both the amount you earn and the way you earn it. Now that you understand the various ways to generate supplemental income, let’s take a closer look at each category of income.
1. How employee supplemental income is taxed
Just like regular wages, whenever you receive additional income, like bonuses and commissions, it is subject to federal income tax, Social Security tax, and Medicare tax. The amount of tax withheld depends on how your employer pays your wages. This rule previously applied to overtime pay, but due to the One Big Beautiful Bill (OBBB) beginning in 2026 (taxes filed in 2026), you’ll be able to deduct up to $12,500 if filing single or up to $25,000 if filing jointly before federal taxes are calculated.
When your employer pays you, they can either choose to combine or separate your supplemental wages from your regular wages. If your supplemental income is included with your regular wages, you will likely have taxes withheld at the same rate as your regular wages.
If your supplemental income is paid separately, your employer may opt to withhold a flat rate of 22% (or up to 37% for amounts over $1,000,000), regardless of your tax bracket or W-4. This is different from regular wages, which are subject to withholding based on your Form W-4 information. We discuss supplemental tax rates further in the following section
Employers typically report supplemental income on Form W-2 at the end of the year. The supplemental income is included in box 1 (wages, tips, other compensation) of your Form W-2, along with your regular wages.
2. How Schedule E supplemental income is taxed
Rental income
If you’re renting out a property, this income is subject to federal and state taxes. Schedule E allows you to deduct rental expenses, such as mortgage interest, property taxes, insurance, maintenance costs, utilities, and depreciation. This income is generally considered a passive-activity, so it is not subject to self-employment tax. However, if you offer significant services primarily for your tenant’s convenience, you may need to report this income on Schedule C and pay self-employment tax.
Royalty income
Royalty income gets taxed as ordinary income at the federal and state levels. The payer typically reports income from royalties using Form 1099-MISC or Form 1099-NEC. These forms provide details about the royalty income received during the tax year, including the total amount paid and any taxes withheld. Although, the payer does not typically withhold taxes for royalty income. Instead, you may need to make estimated tax payments throughout the year. This income may also be subject to self-employment tax if you license or sell intellectual property.
Partnerships and S Corporations
Income from S Corporations or Partnerships is passed through to shareholders or partners and reported on their personal tax returns using Schedule K-1. This income is subject to federal income tax and state taxes. Typically, the entity does not withhold taxes, so as a shareholder or partner, you may need to make quarterly estimated payments to account for your tax liability.
Estates and trusts
Income from estates and trusts is subject to federal and state tax. As the beneficiary, you receive income details on Schedule K-1 reporting your share of income, deductions, and credits. The estate or trust does not typically withhold taxes, so beneficiaries may need to make estimated tax payments.
What is the supplemental tax rate?
Your employer will typically withhold a flat 22% for federal supplemental tax on amounts up to $1 million. Amounts exceeding $1 million may be subject to a 37% tax withholding.
However, it’s important to note that not all types of supplemental income are taxed at the same rate. For example, self-employment income, rental income, royalty income, and income from partnerships or S corporations are taxed at regular income tax rates, which vary based on your total taxable income and filing status. Therefore, the tax rate applied to supplemental income depends on the specific type of income and individual tax circumstances.
What type of extra income is not subject to taxes?
As you go through your tax forms, you might come across other sources of income that you received in addition to your primary income during the year. Although it’s always a good idea to assume that most earnings are taxable, some are exempt from taxation.
- Gifts and inheritances: Money or property received as a gift or inheritance is generally not taxable income for the recipient.
- Scholarships and grants: Funds received as scholarships or grants for educational purposes are often exempt from income tax if they are used for qualified expenses such as tuition, fees, and books.
- Child support: Payments received as child support are not considered taxable income for the recipient parent.
More examples of fully or partially non-taxable income include life insurance proceeds, disability income, welfare payments, and social security income.
Supplemental Income FAQs
In this FAQ section, we answer common questions about supplemental income, including tax rates, example scenarios, and how it differs from other types of income.
What is the difference between supplemental wages and regular wages?
Supplemental wages are additional payments made to employees apart from their regular wages. These payments may include commissions, overtime pay, fringe benefits, severance pay, PTO pay out, or reported tips. Unlike your regular salary, which is usually paid on a fixed schedule, supplemental wages are typically irregular or occasional. As a result, they are subject to different tax withholding rates for federal income tax purposes.
Supplemental income can also be rental income received from owning and renting property. This kind of income is considered supplemental because it is in addition to your regular salary or wages
Is supplemental income the same as Social Security income?
Social Security income and supplemental income may sound similar, but they serve different purposes. Social Security benefits, such as retirement or disability payments, are earned through years of work and paying Social Security taxes. The amount you receive for Social Security is based on your past earnings, and there’s no limit on how much you can have in savings or assets. Supplemental Security Income (SSI) is a program designed to help people who are older, blind, or disabled and who have limited income and resources. SSI doesn’t require any work history, and eligibility is determined by strict income and asset limits.
How much is supplemental income taxed?
Supplemental income is generally taxed at ordinary income tax rates, which vary depending on your total taxable income and filing status. However, certain types of supplemental income, such as bonuses or commissions, may be subject to higher withholding rates for federal income tax, such as the flat rate of 22% for certain supplemental wages.
Why is supplemental income taxed higher than other types of income?
Supplemental pay is typically subject to Social Security and Medicare taxes. However, the way your employer pays you (whether combined with your paycheck or given out separately), can affect whether you have already paid those taxes upfront. To prevent underpayment at the end of the year, the IRS requires a higher tax withholding rate.
Is supplemental security income taxable?
Supplemental Security Income (SSI), often confused with supplemental income, is a government program that provides financial assistance to people who are elderly, blind, or disabled and have very limited income. It’s meant to cover basic needs like food and shelter, and it’s not taxable.
