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How Are Bonuses Taxed?

Nothing feels better than being rewarded for your hard work. Whether it’s an unexpected COVID-19 bonus for being an essential worker, an annual performance bonus, or a holiday perk, a little extra cash is always nice. Keep in mind that regardless of why or when you received your bonus, the IRS will want its cut. If you’re wondering, “How are bonuses taxed?” – no worries, we’ll break it down for you and even provide a bonus tax calculator to help you determine what you’ll owe.

Bonuses Are Supplemental Wages

The IRS categorizes money earned from bonuses as supplemental wages. Other money paid to you by your employer outside of your regular wages also falls into this category, including:

  • Overtime wages
  • Prizes and awards
  • Retroactive pay increases
  • Accumulated sick leave
  • Back pay
  • Reported tips

Money earned through certain commissions are also consider supplemental wages.

How Are Bonuses Taxed?

Supplemental wages, including bonuses, are taxable. Employers withhold taxes from your bonus check using one of two available methods:

The Percentage Method. If you receive your bonus separate from your paycheck, your employer will take 22% out in taxes. This is the most common method used because it keeps things easy for the bookkeeping department.

The Aggregate Method. When your bonus is added into your regular paycheck, your employer will base the amount of taxes withheld on the combined total and what you reported on your W-4. For example, if you typically have 32% withheld from your paycheck, you’ll also have the same amount withheld from your bonus check.

Although you may see less money upfront using the aggregate method, you may qualify for a refund if too much tax is withheld. On the other hand, if too little is withheld, you could be in for an unwelcome tax surprise when you file your return.

Wondering how much you’ll pay in taxes on your bonus check? Use our handy Bonus Tax Calculator below.

Bonus Tax Calculator Piggy Bank

Bonus Tax Calculator

There are two methods for calculating the tax withholding on your bonus:
the Percentage method or the Aggregate method.

The Percentage method is most commonly used by employers. Your bonus will be taxed at a flat 22% rate.

With the Aggregate method, your bonus may be taxed at a higher rate because it is combined with your paycheck earnings.

Different Rules for Bonuses Over $1 Million

For those lucky individuals who receive bonus checks of $1 million or more (yes, they do exist!), the withholding rules differ. The amount up to $1 million is subject to a 22% percent federal withholding tax. Additional funds that exceed $1 million are subject to a 37% tax (or the highest income tax rate for the given year).

Example: A $1.2 million bonus would result in $294,000 withheld in taxes.

$1,000,000 x 22% = $220,000

$200,000 x 37% = $74,000

$220,000 + $74,000 = $294,000

The Exception to the Bonus Tax Rule

There is one type of bonus that is exempt from taxes – employee achievement awards for length of service or safety. In general, the following must be true in order to avoid paying taxes:

  • The award is tangible personal property
  • You did not receive cash, gift certificates, or an equivalent item
  • The value is $1600 or less
  • Your employer gave the award as “part of a meaningful presentation”
  • The length-of-service award was for 5+ years and you have not received any in the last four years
  • Less than 10% of eligible employees received a safety award during the year (managers, administrators, clerical employees, and other professional employees are ineligible)

Other Tax Liabilities

In addition to income tax withholding on your bonus, you may be subject to other tax liabilities, such as:

  • Social Security tax (6.2%) – any portion of your bonus that falls below the $137,700 Social Security cap (2020 tax year) will result in additional taxes being withheld. For 2021, the limit increases to $142,000
  • The 1.45% Medicare tax

You may also be required to pay certain local and state taxes depending on where you live or work.

How to Lower You Tax Liability

Although you can’t avoid paying taxes on your bonus, there are ways to reduce the amount you will owe when it’s time to file your return. For example, you can use some of your bonus money to invest in your 401(k) or an IRA to get a tax break. You can also donate some of the funds to charity or make a contribution to a Health Savings Account (HSA). Other options include prepaying your mortgage or property taxes to offset the tax on your bonus.

For larger bonuses at the end of the year, consider asking your employer to defer the payment until after the new year, especially if the bonus bumps you into higher tax bracket. Keep in mind that this is only beneficial if you do not expect to earn as much the following year or will have more deductions than the current tax year.

It’s important to understand how your bonus money is taxed, so you can prepare for potential consequences when you file. If you need assistance with your tax return, be sure to give Tax Defense Network a call. We can help you find ways to reduce your tax liability and increase your tax refund!