If you’ve ever gotten a bonus at work, you can probably relate to the feeling of excitement and anticipation as you think of all the things you could do with it. But that joy is often replaced by disappointment when you receive your bonus and see just how much was taken out in taxes.
Because the IRS doesn’t consider bonuses to be regular wages, they’re subject to different withholding rules that could result in you receiving a smaller amount than you expected. Here’s a look at how those withholding rules work and what that means for your tax liability.
What Is the IRS Tax Rate on Bonuses?
In most cases, bonuses are subject to a flat withholding rate of 22%. But the amount of tax you’ll ultimately pay on your bonus is equal to your effective tax rate.
Bonuses on your paycheck are treated like other types of income in some ways, meaning they’re subject to income taxes and FICA taxes. However, the IRS requires that employers treat bonuses differently for tax withholding purposes.
This is because bonuses, according to the IRS, are considered supplemental wages, which simply means they aren’t regular wages.
In addition to bonuses, other forms of compensation that are considered supplemental wages include:
Tax Withholding on Supplemental Income
Supplemental wages are treated to the following tax withholding rules:
The Percentage Method
The percentage method is how your bonus is likely to be taxed if it’s given on a separate paycheck from your regular wages.
Assuming you receive less than $1 million in supplemental wages throughout the year, your bonus will be subject to a flat withholding rate of 22%. So a $3,000 bonus, for example, would be subject to $660 of tax withholding.
If you receive more than $1 million in supplemental wages — which isn’t the case for most people — then your bonuses will be subject to withholding at 37%. In this case, that same $3,000 bonus would have $1,110 withheld.
The Aggregate Method
The aggregate method is used when an employer pays a bonus on the same paycheck as your regular wages. This method is more complex and usually results in a higher percentage of taxes being withheld.
When using the aggregate method, an employer must combine your bonus and your regular wages and calculate your taxes as if that’s the amount you earn each paycheck.
For example, let’s say your regular income is $5,000 per month. But in December, you get a Christmas bonus of $1,000. Your employer doesn’t withhold your normal tax rate on your wages and 22% on your bonus. Instead, they do the following:
- Add your wages and bonus together for a total monthly income of $6,000.
- Multiply that monthly income by 12 to assume that’s how much you earn year-round.
- Calculate your marginal tax rate based on the newly calculated income of $72,000 rather than your actual annual income of $60,000.
- Subtract the tax already withheld from the regular wages and withhold the remaining amount from the bonus.
Depending on your income, the aggregate method could result in you paying a considerably higher amount in taxes than you would otherwise need to. In that case, there’s a good chance you would get some of that money back the following year in the form of a tax refund.
Tax Withholding vs. Taxes Owed
Here’s where things get even more confusing. Bonuses and other supplemental wages have different withholding rules than regular income. But they aren’t actually taxed differently. Instead, bonuses are ultimately taxed at your effective tax rate, just like the rest of your income.
Say you have an annual income of $50,000 and a marginal tax rate — meaning the rate at which your highest income is taxed — of 22%.
But when you account for your standard deduction and the fact that most of your income is taxed at lower rates, your tax liability is much lower. If your effective tax rate turns out to be 10%, then your regular income and bonuses are all taxed at roughly 10%.
In that case, if your boss withheld 22% of your bonus, as the IRS requires, then you may end up getting a tax refund for overpayment of your income taxes.
How To Prepare for Bonus Taxes
A bonus can be an extra chunk of money you weren’t planning on, and that simply provides an extra boost toward your savings or financial goals. But in other cases, a bonus might be money you’re banking on for a specific purpose or even to help you pay your bills.
Find Out How You’ll Get the Bonus
To prepare for your bonus taxes, you can start by asking your employer whether the bonus will come in a separate payment or attached to your normal wages. You may even be able to request that the bonus be paid separately so you can more easily estimate the taxes.
From there, you’ll have a better idea of how much money you’ll receive. For example, if you know you’re getting a $2,500 bonus as a separate payment, you can plan for $550 of it to be withheld for taxes. That way, you won’t make bigger plans for the money than what it can actually pay for.
Consider Your Tax Bracket
Another consideration is whether a bonus will push you into a higher tax bracket. If you’re on the cusp of two tax brackets and get a large bonus, you may end up paying a bit more in taxes on all of your income, not just your bonus.
Reduce Your Tax Liability
Finally, consider whether there are ways you can reduce your tax liability. Not only will this help reduce the taxes on your bonus, but it could also help keep you in a lower tax bracket. Here are a few ways to do that:
- Defer your bonus: If you’re having a particularly high-income year or are on the end of two tax brackets, you may be able to request that your employer defer your bonus until the new year.
- Contribute to pre-tax accounts: Pre-tax accounts include 401(k) plans, traditional IRAs and health savings accounts (HSAs). The money you contribute to them reduces your taxable income and, therefore, your tax liability.
- Take advantage of other deductions: There are plenty of deductions available, and it’s important to make sure you’re claiming all of yours. An accountant or good tax software can help you ensure you’re claiming all the deductions you’re eligible for.
The Bottom Line
It can be disappointing to get excited about a bonus only to see a much smaller number than you expected on the check. While it’s true that bonuses are subject to special withholding rules that make it appear that you’re being taxed at a higher rate, that’s not actually the case. Once you file your income tax return the following year, you’ll find your bonus is taxed just like everything else.
So if your bonus is taxed at a higher rate than you expected, don’t get discouraged. You may see that money come back around in the form of a tax refund.
- Are bonuses taxed at 22% or 40%?
- Most bonuses are taxed at 22%, which is the rate for combined supplemental income under $1 million. If your supplemental income for the year is over $1 million, all of that income is subject to 37% withholding.
- Why is my bonus taxed at 35%?
- If your supplemental income totaled over $1 million for the year, it is taxed at 37%.
- Otherwise, the tax on your bonus may have been calculated using the aggregate method, if it was paid on the same paycheck as your regular income. This may increase the percentage of your bonus withheld for taxes, but don't worry – if you overpaid, you'll get that money back as a refund after you file your taxes.
Information is accurate as of March 24, 2023.