Throughout the year, you might receive bonuses from your employer for a variety of reasons. It could be a payment that you get on a regular interval based on company performance. Other times it’s a one-time reward for doing a really good job. The IRS considers bonuses to be supplemental income. It’s because of that they’re subject to specific tax withholding rules. Your employer will choose a specific option for the method by which they’ll pay your bonus and calculate withholding. The option chosen will determine how much of your bonus money you keep. Here’s what you need to know about calculating the tax on bonus payments.
- Contact the payroll or accounting department
In order to know which method is used to pay your bonuses, you need to contact your employer’s payroll or accounting department. Ask if your bonus will be a separate payment or if it’s put together with your regular paycheck. There are major tax differences based on a particular method, so it’s important not to neglect this step. An example would be if you were given a one-time bonus of $10,000 to your paycheck of $35000. This would put you in a different tax bracket, and the amount of income tax you owe would be higher. You can learn more about tax bracket calculations at this link: https://taxfyle.com/tax-bracket-calculator/.
- Know how your employer calculates withholding tax on bonuses
Companies have three options when it comes to calculating taxes on bonuses. One option is the percentage method. A flat rate gets applied to your bonus amount. IRS Publication 15 stipulates a flat tax of 22% on bonuses. Another option is the aggregate method. The employer combines your bonus and your regular income, and then a formula is used to calculate the tax on each separately. The last option is the single payment method. Your regular wages and bonus are combined, taxed, and paid together.
- See if you can choose the payment or calculation method
Large companies might not allow this in order to maintain consistency in how most bonuses are paid out. Smaller employers, however, could be less concerned with the tax calculation or payment method used. This can be helpful to you once you determine the tax implications related to how your bonus paid and how the tax is calculated.
- Using the percentage method
When your employer applies a flat tax rate of 22% to your bonus, that amount will be withheld from it for federal taxes. As an example, let’s say you received a bonus of $1000. Your employer would withhold 22% of it, which would amount to $2200. That will be separate from your regular paycheck, which is the same as usual.
- Using the aggregate method
In this scenario, your employers would add your bonus to the amount of the most recent paycheck you received. Let’s say your regular gross paycheck is $2000, and your bonus is 5000$, adding up to a total of $7000. Then, let’s presume the normal withholding from your regular pay is $500. Your employer would determine the correct withholding amount based on the IRS withholding tables for the $7000 total when calculating the tax. In this example, a figure of $2100 will be used as the total withholding amount. Then, the $500 normally withheld would be subtracted from the $2100. The remaining amount, $1600, would be deducted from the bonus check.
- Using the single payment method
As mentioned earlier, your employer would combine your bonus with your regular pay. Using the same example as the last method, that would amount to $7000. The company would then use the standard IRS withholding tables to calculate the tax. Using the same example again, it would result in a withholding amount of $2100. Keep in mind your employer won’t give you a separate bonus check plus your regular paycheck. You would instead receive one paycheck for the $7000 minus the total withholding of $2100.
- Factor in Medicare, social security, and state withholding
Given that a bonus is a supplemental income, it is subject to Medicare and Social Security withholding. You also have to be mindful that your state could have its own tax rate for supplemental income. All of this has to be taken into account when figuring out your total tax on the bonus. If the math gets complicated for you, consider using a tax calculator to help make it easier.
- See if you can defer the bonus to the end of the year.
When discussing your bonus payment with your employer, ask if it can be deferred until the beginning of the new year. A lot of employers enjoy paying holiday bonuses in December since they can write them off when closing their yearly books on December 31st. In some cases, it might be more beneficial to have your bonus paid the following year. One such example is if you’re expecting to have more deductions in the next year, such as if you plan to buy a house.
- Contribute to your retirement plan
You could reduce your tax liability from your bonus to add it to your retirement plan. This can be done through your 403(b) or 401 (k). If you don’t currently have an employer plan, you could choose to make a traditional IRA contribution instead. Just be aware that there are income limitations with deducting traditional IRA contributions. If this option doesn’t work, there are a variety of others that reduce your tax liability beyond just the ones involving your bonus. One example is adding “green” home improvements. In some cases, it may give you a tax credit of up to 30% of your total cost of improvements. Other possibilities of reducing tax liability you may consider include earning tax-free income or looking into a child-care reimbursement account.
Knowing how to manage taxes with your bonus payments can be fairly simple. It mainly involves knowing how you’re receiving your bonus payment and knowing how the tax will be calculated. Keeping all of these things in mind will help your calculation process go smoothly.