A holiday bonus is a nice way for employers to show appreciation. But, every year, there are people that look down at their bonus in shock. Not because of how little or much their boss gave – but because of how much they think they’re paying in taxes.
To set things straight, let’s start with the simple fact to remember. Your bonus is not taxed more than your regular pay. A person who makes $30,000 in wages and gets a $30,000 bonus pays the same taxes as one who make $60,000 without a bonus.
However, bonuses are considered supplemental wages by the IRS – along with vacation pay, overtime, moving expenses, and commissions – and must be treated differently by employers. As a result, your employer might withhold more money from a bonus than from your standard pay.
Withholdings are meant to estimate the amount you’ll owe in taxes, but they may be incorrect. When too much money is taken out, you’ll get the overpaid amount back when you file your tax return. If your employer doesn’t withhold enough, you’ll need to pay more taxes when you file.
There are two methods that companies can use to determine how much money to withhold from supplemental wages for federal income taxes.
Companies Can Use Two Methods To Withhold Taxes From Bonuses
If the employer specifies the amount of the supplemental wages, usually the case with a bonus as your company wants to show you exactly how much they appreciate you, the company has two options.
- Flat Percentage – 25%
This method is the easiest to remember. The company can withhold a flat 25 percent of the bonus for federal income taxes.
- The Aggregate Method
This method often results in people looking at their paycheck and wondering where their money went. With the aggregate method, the bonus is added to your paycheck, and the entire amount is considered regular wages. However, the withholding’s calculation assumes that your pay plus your bonus is the standard monthly paycheck you receive every month. As a result, it might appear that your annual income is much higher than it actually is and the withholdings will go up accordingly.
Companies use the second method if the amount of supplemental wages isn’t specified. This isn’t likely with an annual bonus, but may be the case if you earn a commission on sales.
The Two Methods in Actions
Let’s run through all two scenarios. We’ll assume that you usually make $4,000 a month, $48,000 a year, and this year you receive a $6,000 bonus.
- Using the percentage method, 25 percent, or $1,500, is withheld for federal income taxes.
- Using the aggregate method, add the bonus to your standard pay and you’ll earn $10,000 for the month that you received the bonus. This rule annualizes the monthly income – treats it as if you earn this amount each month – and the withholdings are based on an annual income of $120,000.
However, you’ll only make $54,000 this year. As a result, more money is withheld than you’ll actually need to pay. You’ll get paid back the difference as a refund when you file your tax return.
Regardless of the method used, you’ll wind up paying the same amount of taxes. Only the withholdings are affected by the method used.
There are special rules for those that receive over one million dollars in supplemental wages throughout the year. Above the one-million-dollar threshold, there is a flat 39.6 percent withholdings rate – the highest federal income tax rate in 2015.
Add FICA and State Withholdings
The above rules apply to federal income tax only. In addition to those, there are also withholdings for Social Security FICA (6.2 percent in 2015/16) and Medicare (1.45 percent) for those that make less than $117,000.
Your state may have its own additional withholding requirements as well. For example, in California supplemental wages can similarly be withheld using the percentage or aggregate method. With the percentage method, bonuses and stock options are withheld at 10.23 percent. Other forms of supplemental wages are withheld at 6.6 percent.
Using the simple percentage method, the withholdings on a $6,000 bonus will be 25 percent (federal income), plus 7.65 (FICA and Medicare), plus 10.23 percent. That’s 42.88 percent, or $2,572.80 – leaving you with a check for $3,427.20.
Don’t Worry About Moving Into a New Tax Rate
Withholdings aside, some people worry that a bonus will push them into a new tax bracket, and they’ll wind up paying more in taxes. Rest assured, that’s not the case. The United States has a marginal tax system, and it’s true that as you earn more you move into a higher tax bracket. However, the tax bracket applies to the next dollar you earn, not every dollar you earn.
For example, in 2015, single filers without dependents are in the 15-percent federal income tax bracket if they make $9,226 to $37,450. Those that make $37,451 to $90,750 are in the 25-percent bracket.
If you make $36,000 as a salary and receive a $4,000 bonus, you’ll move into the 25-percent bracket. But, only the amount from $37,451 to $40,000 ($2,549) is taxed at the 25 percent rate.