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What Is the Bonus Tax Rate?

It’s great to have bonus income, but the net amount can be surprisingly less than you expect. Laura explains how your bonus is taxed and different types of income that get singled out for special tax withholding. Find out how getting a bonus affects contributions to workplace retirement accounts like a 401k or 403b.

By
Laura Adams, MBA,
July 27, 2016
Episode #459

Page 1 of 3

Got a Bonus? What to Know About the Bonus Tax RateIf you’ve been fortunate enough to get a bonus at work, you probably experienced joy and confusion at the same time. It’s great to have extra income, but the net amount you see in your paycheck can be surprisingly less than you expect.

In this post, I’ll explain how your bonus is taxed and different types of income that get singled out for special tax withholding. We’ll also cover how getting a bonus affects contributions to workplace retirement accounts like a 401k or 403b.

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What Is Supplemental versus Regular Income?

There are a variety of situations that might qualify you for a bonus at work. They’re typically tied to performance, such as achieving company goals, accomplishing individual goals, or hitting a combination of both metrics.

For instance, you might receive salary plus a 20% bonus each quarter. Ten percent might come from meeting the performance objectives of your job and the remaining 10% would be paid if the company hits its overall profit target.

An employer might offer you a signing bonus to entice you to leave your current company and take a new job. Or you could receive a retention bonus if you stay with the same company for a certain period of time during an important transition, like a merger or acquisition.

If you relocate for a job, you might be paid a moving bonus that covers some or all of your estimated moving expenses. And if you get fired or retire early, a bonus might be part of a severance or retirement package that also includes unused vacation pay or other benefits.

These are some examples of income that the IRS considers “supplemental wages” because they’re paid in addition to your regular wages. Your employer is required to withhold taxes on supplemental income differently than for your ordinary income.

See also: How to Pay Less in Taxes (Part 1)

What Is the Bonus Tax Rate?

The major point to remember from this article is that bonus income is ultimately taxed the same as your regular pay. The special treatment of withholding for bonus income is to ensure that you don’t have a surprise liability at tax time.

You may be thinking then why does it seem like I end up paying more tax on my bonuses? Keep reading and I’ll explain what happens.

Once the overage is paid back to you as a tax refund, you’ll end up paying the same amount of tax on your supplemental wages as for your regular wages.

Bonus payments are subject to Social Security and Medicare taxes (just like regular wages), but they have different federal and state withholding practices. Your employer can handle the withholding in two different ways: using a percentage method or an aggregate method.

  • The percentage method allows an employer to withhold tax from your bonus at a flat rate of 25% and issue payment separately from your regular pay. This is the most straightforward and simple method. However, in my experience it's not the most common.  Note: If you’re really fortunate and get 7-figure bonus, the IRS withholds amounts above $1 million at 39.6%, in addition to 25% of the amount below $1 million.  
  • The aggregate method is when an employer withholds tax by combining your bonus with your most recent regular pay amount, and uses a tax rate found in withholding tables, which is based on the information you submitted in Form W-4, Employee's Withholding Allowance Certificate.  Let’s say you’re single and make $50,000 a year. Your net withholding for federal taxes typically would be about 15% per paycheck. But if you got an annual bonus of $5,000, the aggregate method calculation would result in 27% withholding from that payment.

However, this higher-than-normal withholding will be credited to you for the year. So when you file your taxes, any amount you've paid that exceeds what you actually owe comes back to you as a tax refund.

In other words, your bonus may be temporarily subject to high withholding, but it won’t be taxed at a higher rate than your ordinary income for the year. Once the overage is paid back to you as a tax refund, you’ll end up paying the same amount of tax on your supplemental wages as for your regular wages.

So while it may seem disappointing to take home a smaller net bonus than you’d like, the upside is that you won’t have to pay extra on tax day. In fact, you’ll likely get a larger tax refund than you expect.

Related article: What Is the Self-Employment Tax?

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