Table of Contents
What is a bonus?
A bonus is a form of compensation awarded to a worker at a company ‘s discretion. Bonuses are normally lout sums that are paid out in addition to a worker ‘s existing wage or wages. Most much, bonuses are distributed on special occasions ( for example, a vacation ) or built into certain compensation plans ( for example, for hitting a quarterly sales goal ). other types include annual, merit, referral, sign-on and retention bonuses.
How are bonuses taxed?
The IRS views any bonus you receive as income. In the short term, that means a collocate of that bonus will be withheld from your check by your employer for taxes. And the fun does n’t stop there : You might besides need to pay state of matter taxes and Medicare and Social Security taxes ( besides called FICA taxes ) on the bonus. In the retentive terminus, the bonus will be added to your sum income for the year. The total amount you received in bonuses for the year will be combined with other gain income and listed in Box 1 of your W-2. When it comes time to file your annual taxes, your total income, including your bonus, gets tax according to your effective tax rate. Employers withhold taxes on your paycheck throughout the class to prepay that tax on your behalf. If you ‘ve had enough withhold, you wo n’t owe anything. If you ‘ve withheld besides a lot or excessively little, that might mean a tax bill or a refund.
Tax withholding on bonuses
Unlike your regular income, the IRS lout bonuses ( and other things such as severance pay and deputation ) into a category called “ auxiliary wages. ” View all sources
Internal Revenue Service. Employer’s Tax Guide (Circular E). Accessed Mar 7, 2022.
even though bonuses are ultimately taxed as even income by the IRS, your employer can use two different methods to calculate withholding. In other words, your employer gets to choose how it wants to do the mathematics on your paycheck. The way those numbers get crunched can impact two things : how a lot of the bonus you ‘ll actually see on your paycheck and your overall tax liability for the year. The two methods the IRS allows for calculating withholding for bonuses and other forms of supplementary income are the percentage method acting and the aggregate method acting.
1. The percentage method
If you receive a bonus individually from your regular paycheck, your employer is likely using the percentage method to calculate how much tax to withhold on your bonus .
- Your sum bonuses for the class get taxed at a 22 % flat rate if they ‘re under $ 1 million .
- If your full bonuses are higher than $ 1 million, the first $ 1 million gets taxed at 22 %, and every dollar over that gets taxed at 37 %. Your employer must use the percentage method if the bonus is over $ 1 million .
How it works:
scenario 1 Ryan receives a $ 2,000 bonus. That bonus gets taxed at 22 %, resulting in $ 440 of the bonus being withheld for taxes. $ 2,000 x 0.22 = $ 440. scenario 2 Julia receives a $ 1.5 million bonus this year. The first $ 1 million gets taxed at 22 % and the remaining $ 500,000 gets taxed at 37 %, resulting in $ 405,000 withhold for taxes. $ 1,000,000 x 0.22 = $ 220,000 $ 500,000 x 0.37 = $ 185,000 $ 220,000 + $ 185,000 = $ 405,000 benefit : The benefit of this percentage method is that it ‘s relatively easily for the employer, so you ‘ll often see taxes withheld this way on bonuses. drawback : The disadvantage of this method is that most people ‘s effective tax rate is not 22 %. If you ‘re in a higher tax bracket, there ‘s a gamble that not adequate of your bonus was withheld for taxes, which can lead to a surprise tax placard at the end of the year. On the other pass, if you ‘re in a lower federal tax bracket, your bonus might get taxed at a higher rate than your regular income. That means more of your bonus will be withheld, but you might get a tax refund when you file.
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2. The aggregate method
The aggregate method acting is the moment way employers can calculate taxes withheld on a bonus. This frequently occurs when your employer lumps your bonus and regular wages into one paycheck .
- Your bonus and your unconstipated income/wages are combined into one paycheck .
- Your payroll department will withhold taxes on the entire aggregate payment at the like rate. That withholding pace depends on your file status and the information you provided on your W4 .
How it works:
Michael ’ s filing condition is single. His regular semiweekly wages are $ 2,000. During this pay period, he besides received a $ 550 bonus, which his employer lumped in concert with his regular income. $ 2,000 ( unconstipated wages ) + $ 550 ( bonus ) = $ 2,550 sum biweekly earnings. According to the IRS ‘s engage bracket withholding board, View all sources
Internal Revenue Service. Publication 15: Federal Income Tax Withholding Methods. Accessed Mar 7, 2022.
benefit : While it ‘s not arrant, the aggregate method acting has a better chance of ensuring that you ‘re withholding enough to cover your tax indebtedness. translation : There ’ s a smaller probability of a surprise tax bill because of your bonus. drawback : It requires more bring for the employer to calculate — and it ‘s silent possible to withhold besides a lot, which could mean a bigger morsel out of your paycheck than necessity. But, on the brilliantly side, it gives you a better opportunity of having an accurate withholding for the year, or possibly a refund.
Aggregate vs. percentage method
The bottom line is that neither the aggregate nor the percentage method is an claim skill. Regardless of the calculation method acting, keep an eye on your full withholding for the year if you get a bonus. If you have a sense for what your sum income will be, you can tinker with your W-4 and adjust your withholding to get out ahead of things before tax prison term.
How to minimize the tax impact of a bonus
1. Review your W-4
Because bonuses can occur at any point during the year, they get added to your wage piecemeal. And that can inflate your earnings, pushing you into a new tax bracket and increasing your tax indebtedness. Before or after your bonus is paid out, it could be deserving doing a little maintenance on your W-4 form to adjust your withholdings. Figuring how much to withhold can be crafty, but our W-4 calculator can help you get a sense for whether you ‘re on the track to owe, get a refund, or zero-out your tax liability. A little fiddle can go a long way toward keeping a tax poster at bay.
2. Make sure your bonus is actually taxable
Make surely that the bonus you ‘re getting is actually … a bonus. The IRS has rules about what it considers taxable. Things like episodic tickets for events, vacation gifts, money for meals while working overtime, flowers, books, and early intermittent low-value fringe benefits are by and large considered nontaxable. View all sources
Internal Revenue Service. De Minimis Fringe Benefits. Accessed Mar 7, 2022.
3. Tax deductions
tax deductions are one of the best-known ways to lower your taxable income and help you offset some of your tax liability. Most taxpayers take the criterion subtraction, but if your individual tax-deductible expenses — such as unreimbursed medical costs, donations or mortgage interest — add up to more than the standard discount, itemizing can help you to trim your taxable income and save on your tax bill.
4. Contribute to a tax-advantaged account
deoxyadenosine monophosphate far as tax-mitigation strategies go, this one might be a win-win for most folks. If you haven ’ thymine hit your annual contribution limit on a tax-advantaged plan, such as your 401 ( thousand ), HSA or a traditional IRA, consider using your bonus toward a qualifying contribution. Because the money you put into these accounts is pre-tax, it can lower your taxable income while besides putting your hard-earned paycheck toward a long-run savings finish.
5. Defer your bonus
Some people might besides ask their employer to defer the bonus until the keep up year. Importantly, doing sol does not eliminate the taxes owed — it merely defers the payment of taxes until a late date. This strategy could make sense if :
- You think your bonus will push you into a higher tax bracket, and you need extra meter to save up for the taxes you might owe .
- You think your full income next class will be lower than the current year, which might lower your tax indebtedness .
Because this can be a catchy scheme to navigate, make sure to consult a tax professional to ensure it ‘s the correct call for your fiscal mental picture .