How Bonuses Are Taxed and Why

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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.

There are two ways to tax your bonus. So, what are the different ways taxes can impact your bonus? And what can you do to limit your tax liability?

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.

But there is also supplemental income for employees. These include commissions, back pay, severance pay, non-deductible moving expenses, etc. It also includes bonus pay. Bonus pay is considered supplemental income because it isn’t part of your regular wages, according to the Internal Revenue Service (IRS). Bonus pay has its own federal 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.

That means if you receive a $6,000 bonus for the year, you‘ll pay a flat $1,320 in withholding taxes. You’ll probably have a withholding tax from your state. And in some cases, you'll also have Social Security and Medicare taxes withheld.

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.

The aggregate method is the second way to withhold your taxes for your bonus. This is used if your bonus is added to your regular paycheck. Taxes for the bonus and your regular pay will be withheld according to what your W-4 states. In other words, your bonus and regular pay will be lumped together.

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.

For example, in 2023, if you are a single filer and earn between $95,375 and $182,100, you fall in the 24 percent tax bracket. The bonus tax was 22 percent. You’ll owe additional taxes.

There’s also the possibility that the bonus pushes you into a new tax bracket. That could also create an additional tax liability.

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.

You can also donate to charity. But you will need to itemize your taxes to take advantage of this.

Plan Your Bonus

If your boss lets you know you’re eligible for a bonus, thank her and then start planning. How can you diminish your liability? The IRS wants their piece, but that doesn’t mean you have to give it to them immediately.

The Epoch Times Copyright © 2023 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.