If you work as an employee, you’re probably used to having income tax withheld from your paycheck. When you get a bonus, however, there may be more confusion about how it’s taxed and what will be left.
Here are the most important things to know about how bonuses are taxed.
Employee bonuses are taxable, just like ordinary wages.
Whether you receive a bonus in the middle of the year or at the end, your employer must withhold 6.2 percent for Social Security tax and 1.45 percent for Medicare tax. Those are the same values they withhold from every paycheck you receive. Your employer then matches those amounts and pays the IRS on your behalf.
Additionally, your employer must withhold Federal and state income tax from your bonus. The bonus amount is also included with your other taxable salaries and wages on your Form W-2 at the end of the year.
Your employer has two options for withholding income tax.
Your employer can determine how much income tax to withhold in one of two ways:
- Aggregate method: Your income tax withholding is calculated as if your bonus was added to one of your regular paychecks.
- Flat percentage method: The IRS allows employers to simply withhold 22 percent from each employee’s bonus for income tax. That is in addition to the Social Security and Medicare taxes as well as any state income tax. If your bonus is over $1 million, the first $1 million has 22 percent tax withheld for Federal income tax. Anything you receive over $1 million is taxed at 37 percent. That method is only available for employees who have income tax withheld from regular wages for the year or the preceding year.
Form W-2 reports your bonus.
When you get your Form W-2 next January, your bonus is already included in your wages and salaries in Box 1. You don’t need to do anything else to report your bonus to the IRS.
Not all “bonuses” are taxable.
If you get small, non-cash bonuses from your employer, you don’t have to report them as income or pay tax on them. Nontaxable bonuses include things like sporting event tickets, holiday parties, and that giant tin of popcorn that takes a month to eat.
Be aware that calling something a “gift” doesn’t make it nontaxable, however. If your employer gives you $500 cash at Christmas, that’s a taxable bonus.
Reduce the tax bite on your bonus.
A little tax planning can help you keep more of your tax bonus – or at least make better use of it. For example, you could increase the amount you contribute to your 401(k) plan or other retirement account to offset the extra tax owed on your bonus.
You could also use part of the money to increase your charitable contributions or other deductible expenditures. If you itemize deductions, that will help reduce your total tax bill for the year.
Adjust your Form W-4 before or after your bonus.
If you want to have more or less income tax withheld from your bonus, you can ask your employer if they use the aggregate method or the flat percentage method. If they use the aggregate amount, you may consider filing a new Form W-4 shortly before the bonuses come out. By increasing your withholding allowances, you’ll have less tax withheld from the bonus. If you decrease your withholding allowances, your employer will withhold more. The choice is dependent upon which is more beneficial to your tax situation.
You can also file a new Form W-4 after you receive your bonus. For example, if you determine that with the withholding on your bonus, you have too much income tax withheld, you can complete a new Form W-4 and increase your allowances. As a result, you’ll get more money in each paycheck for the rest of the year instead of waiting for it to come in the form of a tax refund.