A bonus is a type of payment on top of your regular wages. And you probably wait all year to receive yours. But they’re still income and subject to taxes. You'll note this when you see that your bonus is much smaller than you thought.
Bonuses Are Supplemental Income
Supplemental income is usually money earned outside your regular paycheck. For example, if you have rental property, estates, trusts, royalties, etc. These are declared on Schedule E of your income tax return and have their own tax rate.How Much Are Bonuses Taxed?
Bonuses are taxed at a flat rate. Before the Tax Cuts and Jobs Act (TCJA), bonuses were taxed a flat 25 percent up to $1 million. A bonus over a $1 million was taxed at 39.6 percent. But that changed with the TCJA.The current bonus federal tax rate is 22 percent up to $1 million and 37 percent over $1 million.
Tax Depends on Employer Disbursement
But whether you are slapped with that 22 percent tax depends on how your employer pays the bonus. There are two methods an employer can use to pay a bonus. One way is putting the bonus on its own check, separate from your regular paycheck. The other is combining the bonus with your regular paycheck.Stroking you a separate check for the bonus is called the percentage method. When this happens, your employer will simply withhold the tax at the flat 22 percent rate if your bonus is under $1 million and 37 percent if it’s over $1 million.
Is a Tax Refund Possible?
Is a tax refund possible from that 22 percent you’re paying? It all depends on your tax bracket. You may be owed a tax refund if that 22 percent was higher than your actual income tax bracket for the year.For example, in 2023, if you are a single filer earning between $11,000 and $44,725 in your regular pay, you are in the 12 percent income tax bracket. You'll receive a refund because you’ve paid a 22 percent tax rate on your bonus.
But if you fall into a higher tax bracket than the bonus rate that was withheld, then you might end up owing more taxes.
Ways to Lower Tax Liability
First, make sure your bonus is actually taxable. Money for meals when working overtime, flowers, books, or other intermittent low-value fringe benefits are generally not considered taxable. But it gets murkier if you receive a high-dollar gift, gift card, or just plain cash. Be prepared for tax implications.If the bonus is offered in December, you may want to ask your employer to defer paying it to you until next year. Although this may be kicking the can down the road, if you think your income is going to go down, it might be worth it from a tax savings.
If deferring isn’t an option, then use any tax-advantaged accounts you have. For example, have you contributed the maximum to your 401(k) account? The maximum per year is $20,500. If you have a health savings account (HSA), you can contribute up to $3,650 for an individual or $7,300 for a family. Take advantage of these savings vehicles to lower your tax liability and build on your future.