Is My Annual Bonus Taxed?

Hoorah! You received a year-end bonus from your employer. But the bonus check you receive likely is less than you were promised—22% less. The reason for that, of course, is taxes. Taxes are withheld from bonus checks just as they are from other paychecks—but the withholding rules are different with bonuses, and that can leave some employees wondering, how much are bonuses taxed…and even why are bonuses taxed so high?

Good news: Bonuses are not subject to higher tax rates than other earned income—the same rates apply whether you receive the money in a standard paycheck or a bonus check. But the nuances of tax-withholding rules can make it seem as though different tax rates apply.

“Withholding” is the amount an employer sends to the IRS on an employee’s behalf. Typically, the employer calculates how much to withhold based on the employee’s income and details from that employee’s Form W-4, Employee’s Withholding Certificate.

But with bonuses, employers usually can withhold a straightforward 22%—that’s the IRS’s standard withholding rate for “supplemental wages,” a category that includes things like bonuses, overtime pay, commissions and severance pay. This 22% withholding rate might be higher or lower than the withholding rate applied to an employee’s other paychecks, and that can create the impression that different tax rates apply to bonuses.

Reality: These withholding rates affect only when and how the tax bill is paid. The more money that’s withheld from an employee’s bonus, the larger the refund that employee will receive when he/she files a tax return for that year, assuming that you are in a tax bracket that is less than 22%, or the smaller the amount the employee will owe the IRS at tax time. In other words, the withholding rate comes out in the wash.

Of course, when it comes to taxes, nothing is ever truly simple, so there are a few caveats and complications worth noting…

• If your bonus exceeds $1 million, a 37% withholding rate is likely to be applied to the amount in excess of the million-dollar mark.
• Some employers use what’s known as the “aggregate method” to calculate withholding on bonuses rather than the 22% withholding rate described above. With this aggregate method, the amount withheld from the bonus is calculated much in the same way that the employer determines how much to withhold from the employee’s regular paychecks. The aggregate method is generally used when a bonus is tacked onto an employee’s paycheck rather than issued as a separate payment.
• A small year-end gift from an employer might not be taxable. The IRS differentiates between bonuses paid by employers, which are taxable…and small noncash gifts given by employers, which are not. Rule of thumb: A gift that’s worth less than $100 might fall into this nontaxable “de minimis fringe benefit” category.
• A bonus could push you into a higher tax bracket. If a big bonus lifts your total taxable income for that year from one tax bracket into the next, you could end up paying a higher tax rate on the bonus money after all. Options for avoiding this include asking the employer to defer the bonus to January of the following year…and/or making additional contributions to tax-deferred savings accounts. Some employers may allow their payroll department to withhold a specific amount—in the event you know you are in a higher-than-22% tax bracket.