Receiving a bonus from your employer is a dream come true for many Americans. Spending hours and hours a day working hard deserves its rewards, and a quarterly or yearly bonus is a welcome part of your compensation package. But it is helpful to know how bonuses are taxed. Are they added to your income or taxed separately? Is taking a bonus even worth it?
Review the information below to learn both how bonuses are taxed and how you should approach them. This information is helpful for business owners and employees as the process affects you both.
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Do bonuses add to your income?
In the eyes of your employer, bonuses add to your total compensation. So, your compensation package may include benefits, a $100,000 salary, and a $10,000 — or 10% — annual performance bonus. This makes for a total of $110,000 in annual compensation.
However, the IRS does not see it that way. When you receive a bonus that is not part of your salary, it is taxed at a 22% flat rate for supplemental income, which is known as the percentage method. In some cases, you might also pay for these:
- 6.2% Social Security tax
- Applied to everything under $142,800
- 1.45% Medicare tax
It’s a good idea to reach out to the accounting or bookkeeping division of your company for clarification on how your bonus checks will be taxed. Remember, too, that there is more than one way to receive and/or direct your bonus.
What if your employer adds the bonus to your salary?
If your employer chooses to add your bonus to your salary, then your current withholding level will determine how much is taxed. If you set withholdings at 35%, your bonus will be taxed at 35% — this is known as the aggregate method.
Why would your employer do this to you after all the work you’ve done for them? Because, your employer knows that you will likely receive a refund on this amount for withholding too much tax money.
How to issue bonuses to employees
As mentioned above, bonuses are taxable whether they are tacked on to your salary or issued as an individual check. Business owners might wonder how to issue bonuses to employees, knowing that the IRS is going to want a portion of that money. Here are some options to consider if you are the one handing out the bonus checks.
Because bonuses are considered supplemental wages, they are taxed at a flat rate of 22%. This typically means fewer taxes come out of that initial bonus check, but it also helps the employer issue one round of bonuses once per year, making them easier for employers to track. At the same time, some employees may prefer the aggregate method, opting for a bit of a surprise in their tax refund.
If you’re not sure which avenue to take, consult with your accountant or simply ask your employees which method they would prefer.
Avoiding taxes on bonuses
Finally, avoiding some taxes on bonuses might be possible if that money is put to good use. Direct your bonus to a charitable donation, or contribute to your HSA, 401(k), or traditional IRA to prevent immediate taxation. Additionally, you should come to an understanding of what your tax bracket is. Remember, supplemental income is taxed at 22%. If your tax bracket is below 22%, ask your boss to put your bonus in your paycheck. You save money that you might’ve previously thought was lost.
Plan for your yearly bonus today
While everyone wants a yearly bonus that would allow them to put in a swimming pool a la Clark Griswold, a portion of that bonus will often be eaten up by taxes. Using the information above, you can position yourself to make the most of your yearly bonus, ensuring that you cut back on the tax withholding value as much as possible. That way, you can make sure more of the reward for all your hard work comes to you, and not the IRS.