Are Bonuses Taxed Differently? - The Full Guide


If you're lucky enough to have some great employees working for you, it's natural to want to reward them accordingly. Maybe you're thinking of running an employee-of-the-month scheme, or you feel you should share some of the company profits with the people who made all that possible. Or maybe you have an employee that got the company out of a sticky situation or went the extra mile for a customer.

But, let's be honest. It would suck if your employees had to pay tax on the money you would rather give directly to their bank account. And the unfortunate truth is that bonuses usually do get taxed.

But, what you can do is work out how much tax that would be, so that your accountant can work out how much to give in total so that they can keep a known set amount of money after tax. And that is what this article is principally going to help you with. We will also cover how employees can avoid paying taxes on a bonus check. 

Also read: A Full Breakdown of W2 And 1099 Filing Specifications

Table Of Contents

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A Guide To How Bonuses Can Be Taxed

As you may already know, an employer has to hold back a portion of their employee's paycheck to prepay their taxes. And this goes for bonus checks, too. The funds are sent to the IRS on behalf of the employee in a process called tax withholding.

There are two ways this amount can be calculated for each employee: the percentage method, or the aggregate method. Let's look at each of these methods in turn.

Also read: A Full Guide on How to Calculate Income Tax On A Pay Check

The Percentage Method

This is probably the most common way that employers calculate their tax withholding. 

As an employer taxes employee bonuses using the percentage method, you must identify the bonus as separate from your regular wages. The withholding rate for supplemental wages is 22 percent. 

If you use the percentage method for calculating your withholding, your employer will calculate it based on the gross supplemental wage, before any other taxes are taken out.

So, if you make $10,000 per month, but you receive a one-off $1,000 bonus one year, the employer will calculate a bonus tax withholding of 22% of the $1,000 supplemental income. So, you will end up paying a federal income tax amount of $220 of your bonus, leaving you with a take-home bonus of $780.

Also read: Are Moving Expenses Tax Deductible?

The Aggregate Method

In contrast, the aggregate method calculates the tax withholding by taking into account the entire salary package.

This means that the employer does not need to break down your bonus into smaller amounts. Instead, they just add up all of your earnings and then apply the withholding rate to the total.

So, if you make $50,000 per month, and you receive a one-time $5,000 bonus, the employer will calculate the withholding based on the full $55,000. So, you'll end up paying $550 in federal income tax on your bonus, leaving you a take-home bonus payment of $4,550.

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How Does This Affect Employees?

It's important to remember that both of these methods are used to determine the amount of tax to be withheld. They are not used to determine whether you have to pay tax on your bonus. 

For example, even though you might be paid $100,000 per year, and you might receive a one-off bonus of $20,000, you don't owe any more tax than someone who makes $80,000 per year and receives no extra cash.

Employees should never assume that they will get taxed on a bonus. It's only when they are required to file a return, that they will find out how much tax they owe.

Employers usually send a letter to their employees explaining how they have been taxed on their bonus. 

Also read: Get A Tax ID Number

How To Avoid Paying Taxes On A Bonus Check

You can avoid having to pay taxes on a bonus check by making sure that you're aware of what happens to your bonus when you leave the company.

The best thing you can do is to talk to your human resources department about how you want your bonus treated. You can also ask them to explain how they've handled similar situations in the past.

Some companies will give you a lump sum instead of a bonus check. If this is the case, you should try to negotiate with your employer so that you can keep some or all of the money. 

Some companies may offer you a bonus check, but require you to deposit the check into your bank account within 30 days. In this situation, nothing is stopping you from depositing the check immediately. However, if you wait until after the 30-day period has passed, you could lose the interest earned on the money.

If you're worried about losing interest on your bonus, you can always ask your employer to allow you to withdraw the money before the 30-day period expires.

If you decide to take the money as a bonus rather than a lump sum, it's still possible for you to avoid paying taxes on your bonus.

You can use an IRA or 401(k) plan to defer the taxes on your bonus. The IRS allows employers to treat contributions made to IRAs and 401(k) plans as pre-tax dollars.

When you contribute to an IRA or 401(K), you can deduct the contribution from your gross income. But, once you start withdrawing the funds, you won't be able to claim the deduction.

This means that you can take your bonus money out of your retirement accounts without being hit with additional taxes.

Also read: Change My Direct Deposit Information With The IRS 

money and calculator

Final Thoughts

So, in answer to the original question, yes bonuses can be taxed differently from regular wages, and there are different accepted ways to do this. As for which is the best to use, this will depend on how much an individual's regular paycheck comes to, how much the company is prepared to offer in the way of bonuses, and how frequently those bonuses are given.

There may be times when someone can get away with not paying tax on their bonuses, but these instances are few and far between. 

Our pay stub generator allows you to create pay stubs in a simple and easy-to-use manner.

Frequently Asked Questions

Yes, bonuses are considered supplemental wages, which are payments that are separate from an employee's regular wages, such as overtime pay, commissions, and severance pay.

Yes, bonuses are often taxed differently than regular income using either the percentage method or the aggregate method.

Yes, state taxes may also apply to bonuses, and the rate varies depending on the state in which you reside. Check with your state's department of revenue for specific tax rates.

Yes, in most cases, taxes on bonuses are withheld automatically by your employer using one of the two methods mentioned above.

No, you are legally obligated to pay taxes on your bonus. However, you can minimize your tax liability by making tax-deductible contributions to retirement accounts or adjusting your withholdings.

The choice of tax method is typically at the discretion of your employer, so you may not be able to change it. However, you can discuss your preference with your HR or payroll department.

You can ask your HR department or payroll administrator about the method used for taxing bonuses in your company.

No, only the portion of your income that falls within the higher tax bracket will be taxed at the higher rate. Your bonus might be taxed at a higher rate, but your regular income will remain in the lower tax bracket.

The aggregate method combines your bonus and regular income, calculates the tax on the total, and then subtracts the taxes already withheld from your regular income.

The percentage method is a flat rate of 22% (or 37% for amounts over $1 million) applied to your bonus amount, separate from your regular income tax.
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Are Bonuses Taxed Differently? - The Full Guide
Samantha Clark

A Warrington College of Business graduate, Samantha handles all client relations with our top-tier partners. Read More

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