Bonuses are great, especially when they come during the holidays — a time when more money is going out of your bank account than in. Unfortunately, many employees are unpleasantly surprised when their windfalls turn out to be significantly smaller than expected, due to a bonus federal income tax withholding.
You’re used to paying employment taxes, like the Social Security and Medicare FICA tax, but you might not know about the hit you’ll take on your bonus from Uncle Sam. The percentage of your bonus you’ll lose might depend on what tax-rate calculation method your employer uses. Understand the different ways your bonus can be taxed — and know exactly what you’ll have left of your bonus to spend.
Bonuses Are Taxed Differently
Bonuses aren’t necessarily taxed in the same way your regular salary is because the IRS considers bonuses “supplemental wages.” Other forms of supplemental wages, which are all taxed differently from your regular pay, include:
- Vacation pay
- Moving expenses
- Back pay
- Dismissal or severance pay
How Are Bonuses Taxed?
As far as how much tax on bonuses will cost you, it depends on how your employer figures the bonus tax rate — sometimes referred to as the supplemental tax rate or flat tax rate — for withholding. Employers typically tax bonuses using one of three ways:
- The percentage method: Using this method, figure that your bonus check will be taxed a flat 25 percent. Your employer will withhold the tax for you. So if you get a $1,000 bonus, you’ll take home $750, and $250 in taxes will go the IRS. Employers like this method because it’s easy to calculate.
- The aggregate method: When your employer uses this method, you can figure out how much your bonus will be taxed by combining it with your most recent paycheck and consulting the IRS withholding tables. Your employer will subtract the amount withheld from your paycheck from that total and withhold the rest from your bonus.
- The million-plus method: For bonuses in excess of a million dollars in one calendar year, it’s easy to figure out the tax: It’s set at 39.6 percent for the amount exceeding $1 million and 25 percent — or at the rate determined by the aggregate method — for the amount below $1 million.
Here’s the catch: The two main methods — percentage or aggregate — could net you different amounts for the same bonus. In fact, if your boss uses the aggregate method, you could end up paying more than 25 percent of your bonus to taxes.
What the Bonus Tax Rate Means for Your Tax Refund
Don’t panic over losing money because your employer decides on the less favorable method to tax your bonus. Your actual tax rate is based on not only your taxable income but your tax deductions and credits as well. So, yes, the aggregate method could result in your getting a smaller bonus initially — but depending on your actual tax rate, you might get some of that money back in the form of a tax refund.
When you file your taxes, you don’t need a different form to report your bonus pay. Your employer will add the amount of your bonus to the wages and salary listed in box 1 on your W-2. Because your bonus will add to your adjusted gross income, you might end up owing a higher amount of tax.
Knowing in advance that Uncle Sam is going to take his cut from your bonus gives you the power to prepare. That might even include asking your boss if there’s a way to ensure the company withholds taxes using the method that’s most beneficial to you. After all, it’s your bonus on the line.
Barri Segal contributed to the reporting for this article.