Congrats on that Bonus! Do You Understand How It Will Be Taxed?

Employees in every industry appreciate a bonus to their current salaries.  We all love being recognized for our work, especially if it involves money. However, as we reach for the bonus check, don’t forget the IRS will also have their hand out. It’s important to understand how bonuses are taxed before spending your earnings.

What to Know About Taxes on Your Bonus
The IRS considers a bonus a Supplemental wage*, something other than your regular pay and, therefore, subject to its own withholding rules. As a result, you will have to pay taxes on it as you do with your regular salary or hourly wage.

Additionally, it’s up to your employer to decide how they want to handle your bonus. Your employer may choose to:

  • Combine it with regular wages
  • Separate it from regular wages

Combining Supplemental Wages with Regular Wages
If your employers combine your bonus with regular wages, the IRS says withholdings would be on the total amount as if it were a single payment during a regular payroll period.

Separating Supplemental Wages from Regular Wages
If your bonus IS identified as such, the withholding calculation still depends on your employer. The Federal withholding can be calculated in two different ways:

By Percentage
The percentage method is a flat 22% with your bonus paid separately from your regular pay and taxed directly. This rate applies to bonuses under $1 million.

By Aggregate
Your employer included your bonus in your most recent regular paycheck, referencing the Federal withholding tables to determine how much should be taken out for taxes. If your tax bracket is lower than 22%, you may be better off having your employer include your bonus with your regular pay, so you would pay less tax.

Whichever calculation method is used, it’s always best to consult your trusted tax advisor to ensure you are not underpaying your taxes.

What if it’s a REALLY Nice Bonus?
Don’t spend it all yet! Supplemental wages in excess of $1 million are treated differently. The first $1 million is subject to a 22% withholding rate (2019), and the amount over $1 million is subject to 37% withholding (or the highest rate of Federal income tax for the year).

What is Best?
Employers may opt for the percentage method, as it’s much easier to calculate. However, in terms of what might benefit you most, the answer might come down to your tax bracket. There is probably no harm in asking your employer which method they will be using to ensure you are aware of the consequences to your earnings.

And don’t forget that no matter how your employer treats your bonus, your bonus is still subject to Medicare, Social Security, and any applicable state income taxes.

Still have questions? Consult the experts at Leone, McDonnell & Roberts, PA for guidance.

* As defined by the IRS: Supplemental wages are wage payments to an employee that aren’t regular wages. They include, but aren’t limited to, bonuses, commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, retroactive pay increases, and payments for nondeductible moving expenses.