Bonuses are great, especially when they come during the holidays — a time when a lot of money is going out of your bank account, not entering it. If you’re wondering, “Are bonuses taxed?” — the answer is yes. Unfortunately, many employees are unpleasantly surprised when their windfalls turn out to be significantly smaller than they thought they’d be, due to a bonus tax federal withholding.
That’s right: When you get a bonus, Uncle Sam gets one, too — or, at least a chunk of yours when you file your taxes. But how big a chunk of your hard-earned bonus the federal government gets might depend on what method your employer uses to calculate the tax rate on bonuses.
Bonuses aren’t necessarily taxed in the same way your regular salary is because the IRS considers bonuses to be “supplemental wages.” Other forms of supplemental wages include overtime, vacation pay, moving expenses, commissions, back pay, and severance or dismissal pay. All of these are taxed differently from your regular pay.
How Are Bonuses Taxed?
As far as how much that tax on bonuses will cost you, it depends on how your employer figures the bonus tax rate for withholding. Employers tax bonuses in one of two ways: by the percentage or the aggregate method.
- The Percentage Method: Employers like this method because it’s easy to calculate — your bonus is taxed a flat 25 percent, which your employer withholds. So if you get a $1,000 bonus, you’ll take home $750.
- The Aggregate Method: If your employer uses this method, he combines your bonus with your most recent paycheck and figures out the amount to withhold using the IRS withholding tables. He then subtracts the amount withheld from your paycheck from that total and withholds the rest from your bonus.
Here’s the catch: The two methods could net you different amounts for the same bonus. In fact, if your boss uses the aggregate method, you could end up paying more than 25 percent of your bonus to taxes because the IRS withholding table goes up to 39.6 percent — if you’re lucky enough to get a bonus of more than $1 million in a single calendar year, it will be exactly 39.6 percent.
And here’s a free tax tip: If your bonus is going to put you into a higher tax bracket this year and you expect to earn less next year, consider asking your boss to defer your bonus until after the new year.
What the Bonus Tax Rate Means for Your Tax Refund
If you’re stressing over losing money because your employer decides on the wrong method to tax your bonus, don’t worry too much — your actual tax rate is based on not only your taxable income, but your tax deductions and credits as well.
So, yes, the aggregate method could result in your getting a smaller bonus — but depending on your actual tax rate, you might get some of that money back in the form of a tax refund.
Even though your bonus is subject to withholding, remember to be grateful you even got one. Knowing in advance that Uncle Sam is going to take his cut gives you the power to prepare. That might even include asking your boss if there’s a way to ensure the company withholds taxes on it using the method that’s most beneficial to you. After all, it’s your bonus on the line.