What is the tax rate on a bonus check?
Getting a bonus is recognition of a job well done, stand-out performance or years of good service. However, the IRS views your bonus as a form of wages, subject to federal taxes and other deductions. So how do you make the most of your hard-won bonus and minimize your tax liability?
What exactly is a bonus?
A bonus is a kind of compensation your employer pays over and above your regular salary.
They tend to be paid in recognition of special achievements, reaching certain goals or perhaps at the end of a financial year. Companies are not obliged to offer you a bonus – unless explicitly stated in your employee contract – and they can be paid at any time throughout the year.
It’s important to understand the tax implications of receiving a bonus before your employer pays you one.
What is the tax rate on a bonus check?
Your bonus might feel special, but you have to pay state and federal taxes like any income. So, no matter your tax bracket, you pay a flat 22 percent withholding rate.
How is your bonus taxed?
It’s not just federal tax you need to consider. You might have to pay Medicare and Social Security tax, unemployment tax and, depending on where you live, local and state taxes.
Being subject to federal tax, your W-2 statement will include your bonus in Box 1, where you’ll find the wages that are taxed in this way.
The IRS views bonuses as supplemental income, so your employer must withhold taxes on bonuses according to their regulations. This is a separate withholding calculation from your regular salary, and how these regulations affect you depends on the size of your bonus, your W-4 information, and how your employer calculates withholdings.
How does bonus tax withholding work?
The IRS gives your employer two choices regarding withholding federal tax on your bonus: the percentage method and the aggregate method. We take a look at the pros and cons of each.
The percentage method
This is the easiest option to calculate and is often used when your employer offers a bonus as a separate payment. It uses a flat-rate system where your employer withholds 22 percent on the first $1 million and an additional 37 percent on any amount over $1 million.
So, if you receive a $3,500 bonus, your employer will withhold 22 percent in federal taxes, which will generate a total federal tax withholding of $770, worked out like this:
$3,500 x 0.22 = $770
If you receive a $1.3 million bonus, your employer will withhold 22 percent of the first $1 million and an additional 37 percent on the remaining $300,000. This would create a total federal tax withholding of $331,000, worked out like this:
$1m x 0.22 = $220,000
$300,000 x 0.37 = $111,000
Total federal tax = $331,000
The pros – the percentage method is easy to calculate for employers, but it’s also simpler for you to see how much federal tax withholding will affect your bonus.
The cons – using a flat percentage rate may not accurately reflect how these wages are taxed on your return. So, if your marginal tax rate exceeds 22 percent, your employer might not have withheld enough tax. This could mean you owe more tax on your next return. Conversely, if your marginal tax rate is less than 22 percent, your employer might withhold more tax than you need to pay. This would mean waiting until you file your tax return to get a refund.
The aggregate method
The main difference is that your employer won’t pay you a separate bonus; they will add it to your regular earnings. It means they will be taxing your bonus and regular income at the same rate, based on the information in your W-4 form.
So, for example, if your filing status is single and you earn $2,500 every two weeks, plus you receive a bonus of $1,000, your earnings for that period will be $3,500. Your federal tax withholdings will be based on the total amount of $3,500.
The pros – the biggest pro with the aggregate method is that it tends to provide a more accurate result because it uses your personal W-4 information. This means there’s a better chance of the right tax rate being used.
The cons – although the latest payroll technology handles calculations automatically, this method is still more time-consuming for your employer. Your regular earnings and bonus are combined in one check, so you may get pushed into a higher tax bracket. This will increase the chance of over-withholding, resulting in your bonus being taxed at a higher rate than necessary.
How can you reduce the tax on your bonus?
When you earn a bonus, it will have a noticeable impact on your tax payments. That’s why it pays to know what steps you can take to minimize the impact, these include:
Tax deductions – when filing your taxes, you can choose between standard and itemized deductions. Exploring your options and deciding which deduction type works best for you is important. One suggestion is to calculate your deductions using both methods to pinpoint the best way. Consider using a financial advisor or tax professional to help you make the right choice.
Look at your W-4 – checking and adjusting your W-4 could reduce your tax liability, but if you’re unsure how to go about it, take a look at the IRS tax withholding estimator. This simple tool will let you add your information and estimate whether your taxes are too high, too low or spot on.
Defer your bonus – if you know you have a bonus coming, you may be able to ask your employer to defer the bonus until the following year. This means you won’t be able to access the money until then, and if you move into a higher tax bracket, you might have to pay more. But equally, you might move into a lower tax bracket – especially if you’re close to retirement or going part-time. This is where deferring makes the most sense. Another reason for considering this strategy is if you can’t afford the extra tax liability this year and need some time to save and pay it.
Get a tax-advantaged account – you could also consider contributing to a tax-advantaged account, such as a 401(k), IRA, or Health Savings Account (HSA). This would enable you to use some of your bonus to make a qualifying contribution. These are made on a pre-tax basis, so they can lower your overall liability. Just ensure you don’t exceed the annual contribution limit, or you could trigger unwanted tax penalties.
The bottom line
Earning yourself a bonus is exciting and inspiring. But it’s easy and understandable to forget about the impact that tax withholdings can have.
A financial advisor can suggest the best way to maximize your bonus.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.