How Annual Bonuses Are Taxed — 7 Common Questions Answered
Everybody loves an annual bonus. Not everyone understands how bonuses affect their tax returns, however, or even what is considered to be a bonus by the Internal Revenue Service (IRS).
Sometimes, when people receive an annual bonus from their employer, they are surprised at how small it is after tax. They may even wonder if their employer correctly calculated the withholding tax.
Following are some common questions about bonuses and the IRS, along with the answers you need to know.
Why does my employer withhold more from my bonus than from regular pay?
If you receive a bonus or other supplemental income separate from your regular pay, your employer must use an IRS-approved method to determine how much tax should be withheld.
Your employer calculates the withholding amount based on your pay, the time period, and the information on the IRS Form W-4 you filled out.
Alternatively, your employer has the option of withholding a flat 25 percent income tax from your bonus amount.
Are bonuses subject to payroll taxes?
Yes, you and your employer must pay payroll taxes on bonuses, just as you do with your regular pay.
Could my employer have made a mistake?
It happens. If your payroll department calculates withholding tax by hand, they could inadvertently read the wrong column or look at an incorrect form.
Even companies that use payroll software or services can accidentally enter the wrong information.
Most of the time, however, the withholding tax on bonuses is calculated according to IRS rules. If you have questions about the amount withheld from your bonus, the best first step is to talk to your payroll department.
I’m sure they withheld more tax than necessary. What can I do?
Assuming your employer calculated the bonus withholding correctly, you cannot get the withheld tax back from the IRS until you file next year’s tax return.
An easy way to even out the amount you have withheld is to file a new Form W-4. Adjusting your withholdings can reduce the amount of tax withheld from your pay for the rest of the year. Be sure to file another Form W-4 next year or whenever you need to adjust it again.
How can I prevent overwithholding from my bonus next year?
The easiest way to have less tax withheld from your bonus and your regular pay is to claim additional withholding allowances on Form W-4. Ask for a new form from your payroll department or get one from the IRS website.
Another option is to use TaxAct to calculate your withholding allowances (sign in to your return and click on the “Next Year” tab). Simply print the new Form W-4 and submit it to your payroll department.
Keep in mind that you can claim as many allowances as you need to in order to have the correct amount withheld from your pay.
You are not limited to the number of dependents you have or to the amount you calculate on the IRS worksheet.
Ask your payroll department how long it takes for a new Form W-4 to take effect, and submit the new form before you expect a bonus check. Do not send the form to the IRS.
You can file another Form W-4 after you receive your bonus, or at any time during the year when you need to change your withholding amount.
What counts as a bonus for tax purposes?
A bonus, according to the IRS, is any payment made from an employer to an employee that is in addition to regular compensation.
It can be cash or non-cash. A holiday bonus is taxable, even if it is presented as a gift. If you receive a small non-cash holiday gift from your employer, such as a ham or popcorn tin, you don’t have to claim it as a bonus, however.
The IRS specifically excludes such “de minimus fringe benefits” from taxation.
Can getting a bonus bump me into a higher tax bracket?
It’s possible that a bonus, or an increase in pay, can put you in a higher tax bracket. That means you will pay a higher tax rate on each additional dollar you earn.
Some people think they may actually have less after-tax income because of a bonus, but this is not true.
Being in a higher tax bracket does not change the rate you pay on everything you earn – only the rate you pay on taxable income that exceeds a certain amount.
So, relax and enjoy your bonus!