Withholding Rates on Deferred Compensation

[Guest justbe]

A participant is receiving a distribution under a SERP upon termination of employment. The distribution will be in a lump sum. The wages will be reported on a Form W-2 - At what rate should taxes be withheld? The individual's regular tax rate or can the participant specify what rate he or she wants. Thoughts?

[Harwood]

I've always assumed you use the payroll rules for Supplemental Wages, as found in Publication 15 - Circular E, Employer’s Tax Guide:

Supplemental wages combined with regular wages.

If you pay supplemental wages with regular wages but do not specify the amount of each, withhold income tax as if the total were a single payment for a regular payroll period.

Supplemental wages identified separately from regular wages.

If you pay supplemental wages separately (or combine them in a single payment and specify the amount of each), the income tax withholding method depends partly on whether you withhold income tax from your employee’s regular wages:

1) If you withheld income tax from an employee’s regular wages, you can use one of the following methods for the supplemental wages:

a) Withhold a flat 25% (no other percentage allowed).

b) Add the supplemental and regular wages for the most recent payroll period this year. Then figure the income tax withholding as if the total was a single payment. Subtract the tax already withheld from the regular wages. Withhold the remaining tax from the supplemental wages.

2) If you did not withhold income tax from the employee’s regular wages, use method 1-b above. (This would occur, for example, when the value of the employee’s withholding allowances claimed on Form W-4 is more than the wages.)