You’ve worked hard to earn that long-awaited bonus but have a question. Are bonuses taxed higher? You might be surprised to learn that your bonus can be taxed at a higher rate than your regular earnings. In fact, the IRS imposes a tax rate of 22% on the first $1 million in bonus income and a tax rate of 37% on anything above that.
Even the 22% tax bill can make a bonus feel less exciting. But knowing the rules regarding bonus taxation — and how bonuses affect your tax return — can help you to prepare. The information below can help you understand and minimize the taxes associated with bonuses.
How Are Bonuses Taxed?
The IRS subjects your bonus to Social Security, Medicare and income taxes just like it does your regular income. But because the IRS defines bonus income as supplemental, different rules apply as to how much tax is withheld from your check. Since you might ask yourself “Why did I get taxed so much on my bonus?”, it helps to understand that employers withhold taxes using one of the following two methods:
As the name implies, this method involves holding back a specific percentage of the bonus. Your employer may choose this option if it pays your bonus separately from your regular earnings or otherwise distinguishes your bonus from your regular earnings.
Assuming the bonus amounts to $1 million or less, the employer will withhold 22% — the bonus tax rate for tax year 2022 — in most cases. So, if you receive a $10,000 bonus, the employer will withhold $2,200 for income tax. The percentage increases to 37% on bonus earnings above $1 million.
Employers use the aggregate method when they include bonus pay with an employee’s regular earnings. Under this method, the IRS still defines bonuses as supplemental income, but the employer treats the bonus portion as regular pay for tax withholding and uses the information on your W-4 form to determine what percentage of the total earnings to withhold.
The aggregate method can result in the employer withholding more tax than the employee owes, leading to a lower bonus payment. Do you get that bonus tax back with your refund? Provided you don’t owe additional taxes for earnings on a side job as an independent contractor, for example, you will get the excess withholding back with your tax refund.
If you do have a side job, bonuses can help your tax return. The excess money you’ve paid in taxes on the bonus can defray some of the taxes you owe on your additional, untaxed income.
Learn: Tax Mistakes Everyone Makes and How To Avoid Them
How Do Bonuses Affect Your Tax Refund?
Because bonuses are taxed at a different rate than your regular income, you might find that your refund is less than you expected.
If, for example, your income falls into the 12% tax bracket, you might have been expecting to pay that 12% on your bonus income, too. But because your bonus will be taxed at a minimum of 22%, you won’t get quite as much back in your refund.
Do You Get Bonus Tax Back With Your Refund?
If you overpaid the taxes on your bonus — say your employer used the aggregate method and ended up withholding more than was necessary — you would receive the extra back in your refund, assuming you didn’t owe taxes on any other income.
Exceptions to the Usual Bonus Rules
As mentioned, tax withholding depends on your individual tax situation. Special circumstances can subject you to a higher tax rate or place you in a different tax category.
Bonuses Over $1 Million
The IRS taxes your first $1 million in bonuses at the standard 22% tax rate. But different rules apply for bonuses above $1 million. All bonus money received over the $1 million threshold has a tax rate of 37%, so an employer using the percentage method will withhold 37% of that portion of the bonus for tax purposes.
So, for example, if you received a bonus of $1.1 million, the first $1 million would be subject to 22% withholding and the remaining $100,000 would be subject to 37% withholding.
Incentive payments work differently than bonuses or regular wages. The IRS considers these earnings to be non-employee compensation. An example is a car salesman who earns bonus income from the auto manufacturer instead of the dealership that employs him.
Your employer doesn’t withhold tax from non-employee compensation, nor does it report the income on your W-2. Instead, the company that issued your payment will report your earnings on a 1099-MISC or 1099-NEC. You report the payments on Schedule 1 if you’re an employee, or Schedule C if you’re self-employed. You might have to file Form 1040-ES to report and pay the estimated tax on those earnings.
See: Tax Season 2023: 6 Reasons You Can Get Audited This Year
How Can You Avoid Paying Taxes On Your Bonus?
You will likely want to minimize the effect of the bonus on your tax return. Fortunately, the tax code offers some loopholes for this purpose. You can take advantage of commonly-missed tax deductions, for example, or donate some or all of your bonus to help to minimize the tax burden.
That said, tax-deferred accounts might offer the most straightforward solution for avoiding taxes on bonus earnings.
These accounts come in many forms, such as a health savings account you fund from pre-tax earnings to pay medical expenses. But most tax savings revolve around retirement accounts, such as a 401(k), IRA or Roth IRA.
Learn: Find Out If You Can Really Write Off That Holiday Donation
The Bottom Line
In the event you’re due a bonus, you should make yourself aware of the effects of that money on your tax return while maintaining a degree of perspective. You will come out ahead, regardless of whether your employer uses the percentage method or the aggregate method to determine tax withholding.
The payout can provide an opportunity to fund accounts previously ignored. Perhaps you could fully fund your health savings account, 401(k) or IRA if you have not already contributed the maximum. Such accounts can help you escape some or all of the income taxes associated with the bonus.
The financial windfall a bonus provides can have unexpected repercussions. But by knowing how to handle the possible tax consequences, receiving the extra money will be less taxing in the end, both emotionally and financially.
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FAQHere are the answers to some common questions about bonus taxes.
- Do bonuses help my tax return?
- Generally, no, getting a bonus would not help your tax return. However, if you owe taxes on other income and had more than was necessary withheld from your bonus, you might end up in a better position come tax time. The additional tax withheld from your bonus could reduce the amount you owe on other income, or even help you break even.
- Why did I get taxed so much on my bonus?
- Bonuses are taxed at a higher rate than some tax brackets – at least 22%, while the lowest tax bracket is 10% – you might be surprised to see how much of your bonus was withheld for taxes. You might also find more withheld than you expected if your employer used the aggregate method to calculate the withholding.
- However, worry not – if you did overpay the tax on your bonus, you should get it back with your tax refund.
Daria Uhlig and Jami Farkas contributed to the reporting for this article.
Information is accurate as of March 31, 2023.