Did you receive a Christmas bonus this year? Wondering where it all went after it was withheld? Let’s dive into the details of how a bonus is taxed.
There is nothing like being rewarded for your hard work at the end of the year. The holidays are present, the family is around, and you just brought in the new year with a bonus. You might want to buy something nice for your significant other, buy that present your child has been desperately asking for, or maybe you’re thinking about your future and want to put the check into your savings. Either way, it’s best you understand the difference in how bonuses are taxed when compared to regular income.
Bonuses as Supplemental Wages
The IRS categorizes different types of income. Bonuses are considered supplemental wages. But what does this mean? The IRS explains:
“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.”
With this in mind, bonuses are treated differently than ordinary wages or salary when it comes to withholding. To make matters more confusing, you can use two formulas to calculate tax on a bonus: the percentage method and the aggregate method. But which one should be applied to your bonus?
The percentage method used to calculate withholding for a bonus is rather simple. It is a flat rate of 22%. This means that any bonus (and other supplemental wages) would be taxed at this rate. Simple right? So, let’s say you received a bonus of $1,000 this year. Instead of your normal withholding rate for ordinary income, the bonus is withheld at the flat rate. This means that $220 of your bonus will go straight to the IRS (22% of $1,000). This is often the preferred method of taxation by employers as it is not as complex as the aggregate method.
The aggregate method consists of your employer paying your bonus with your latest paycheck. Then they would decide the correct withholding amount based on IRS withholding tables for the aggregate of both amounts, less what was previously withheld from your paycheck and withhold the rest from the bonus amount.
Large bonuses Greater Than $1 million
If you pay attention to business news, it is not uncommon to hear about executives receiving large bonuses tied to performance and the company's stock price. If you are one of these executives, expect to get a hefty withholding tax on your bonus. If you receive a bonus greater than $1 million, your employer must withhold 37% of the amount greater than $1 million and the standard 22% of the amount below $1 million.
Bonuses are always a welcome aspect of working for a company. To many, it can be a surprise when they see how much of their bonus was withheld. Are you trying to figure out the tax for your bonus? Try our Bonus Pay Percent or Bonus Pay Aggregate calculators to aid in the process!
These free resources should not be taken as tax or legal advice. Content provided is intended as general information. Tax regulations and laws change and the impact of laws can vary. Consult a tax advisor, CPA or lawyer for guidance on your specific situation.