Supplemental Income Tax Rate

What Is the Supplemental Income Tax Rate?

The supplemental income tax rate is the flat withholding rate the IRS requires employers to use when withholding federal income tax on supplemental wages. Supplemental wages are payments made in addition to an employee's regular salary — including bonuses, commissions, severance, and critically, income from equity compensation events such as NSO exercises, RSU vesting, and ESPP disqualifying dispositions.

The current federal supplemental withholding rates are:

• 22% on the first $1 million of supplemental wages per year
• 37% on supplemental wages exceeding $1 million per year

These are flat rates — they do not adjust based on your actual income level or tax bracket. This simplicity is convenient for payroll processing but frequently results in withholding that does not match your true tax liability.

How the Supplemental Rate Works

Application to Equity Events

When you exercise NSOs, the spread (FMV minus exercise price) multiplied by the number of shares is supplemental income. Your employer withholds federal income tax at 22% (or 37% if your cumulative supplemental wages for the year exceed $1 million) from this amount.

Similarly, when RSUs vest, the FMV of the vested shares is supplemental income, and the same withholding rates apply.

The $1 Million Threshold

The $1 million threshold for the higher 37% rate is cumulative across all supplemental wages in a calendar year — not per event. If you received a $200,000 bonus in March and exercise NSOs with a $900,000 spread in October, the first $800,000 of the exercise spread is withheld at 22% (bringing cumulative supplemental to $1 million), and the remaining $100,000 is withheld at 37%.

Aggregate vs. Percentage Method

Employers can use either the flat percentage method (described above) or the aggregate method, which calculates withholding by adding the supplemental wages to your most recent regular paycheck and computing the withholding on the combined amount. The percentage method is far more common for equity events.

Practical Implications for Startup Employees

Under-Withholding for High Earners

If your total income (salary plus equity income) puts you in the 32%, 35%, or 37% federal bracket, the 22% supplemental rate does not cover your actual tax liability. After adding state taxes and payroll taxes, the gap can be substantial.

Example: RSU vest worth $200,000. Federal withholding at 22% = $44,000. But your actual marginal federal rate is 35%, meaning your true federal tax is $70,000. You owe an additional $26,000 — plus any state tax shortfall.

Over-Withholding at the $1M Threshold

Conversely, if a single large equity event pushes you above $1 million in supplemental wages, the 37% rate may exceed your actual marginal rate for some of the income. In this case, you will receive a refund when you file, but the cash flow impact during the year is negative.

Planning Around the Rates

Understanding the supplemental rate helps you plan liquidity. If you know RSUs are vesting and the employer will sell-to-cover at the supplemental rate, you can calculate how many shares you will actually receive. For a $100,000 RSU vest, roughly 22% of shares will be sold for federal tax (plus state and payroll), leaving you with approximately 55-65% of the shares depending on your state.

Adjusting for Shortfalls

If you anticipate under-withholding, you have two options: (1) increase your regular W-2 withholding through your employer by submitting a new W-4 with additional withholding, or (2) make quarterly estimated tax payments. Either approach avoids an underpayment penalty at filing.

How It Relates to Exercising Stock Options

The supplemental income tax rate directly determines how much tax is withheld at the time of your NSO exercise. If you are planning a sell-to-cover exercise, the supplemental rate dictates how many shares are sold and how many you keep. If you are doing a cash exercise of NSOs, the withholding may come from your paycheck or require a separate payment. For ISOs, the supplemental rate is not relevant because there is no withholding at exercise — but understanding it helps you compare the cash flow impact of exercising ISOs (pay AMT later) versus NSOs (tax withheld immediately at the supplemental rate).