You just got a bonus at work and you are not sure if it’s taxable or not right? Well, You’re not alone. A lot of people don’t know if their bonuses are taxable or not.
The good news is that it depends on the type of bonus you receive. Generally, bonuses are considered taxable income unless they are specifically designated as non-taxable.
Is bonus taxable? Bonus is taxable because it is regarded as a supplementary wage. The employer subtracts the amount of federal taxes previously deducted from regular pay when determining the total amount of taxes that would have been withheld if the bonus and basic pay were combined.
Is Bonus Taxable?
Bonuses are taxable, as the IRS states in its Employer’s Tax Guide: “Supplemental pay is compensation paid in addition to an employee’s regular wages. They include bonuses, commissions, overtime pay, payments for accrued sick leave, severance pay, honors, prizes, back pay repayments for nondeductible moving expenses.”
The amount of federal taxes withheld from the bonus will be determined by your answer to the following question: Was the bonus combined with regular wages or treated as a separate item? If an employer combines the bonus with regular pay (and it’s not identified separately), the entire amount (including both components) will be taxed in one tax bracket.
If an employer decides to separate the bonus from regular pay, he or she must choose how to tax it. The IRS permits employers to withhold a flat percentage of the bonus amount.
The second choice is to apply the bonus amount to the preceding pay period’s regular wage. The employer will then calculate how much federal tax would have been taken had all of the employees been eligible for a bonus.
The employer calculates the amount of taxes that would have been withheld from the bonus and regular wages if they were combined by subtracting the outstanding federal tax figure from the total normal pay. The quantity to be deducted from the bonus check is determined by this decrease in tax amounts.
Calculating Taxes On Bonus
A bonus is always a pleasant boost to income, but it is taxed differently from ordinary earnings. The IRS considers bonuses to be “supplemental wages” and charges a flat 22 percent federal withholding rate rather than adding it to your regular income and taxing you at the top marginal rate.
Bonuses are considered “supplemental wages” by the IRS. According to the IRS, a supplemental wage is a money paid to an employee that isn’t included in his or her regular pay. In general, bonuses of any kind, such as signing bonuses and severance pay, are considered supplemental wages.
Employers are allowed to utilize one of two methods for calculating their tax withholding: the percentage method or the aggregate method.
The Percentage Method
The flat-rate approach, also known as the percentage method, is the most straightforward technique for employers to calculate taxes on a bonus. It typically pays off financially at least initially.
When an employer calculates a bonus using the percentage method, it must distinguish the incentive from your normal pay. The supplemental wage withholding rate is 22%. During the tax year, any additional payments such as bonuses up to $1 million are taxed at a rate of 22 percent. If your bonus is greater than $1 million, the withholding rate for any amount increases to 37%.
You’ll pay a 22% federal tax in addition to Social Security (or FICA) and Medicare taxes. State income tax may also be imposed, depending on your state of residence. The current combined Social Security and Medicare tax rate is 7.65 percent.
The Aggregate Method
Bonuses are sometimes paid in addition to regular salaries. In this case, your employer must use the aggregate approach to calculate your bonus’s initial tax withholdings. The consequence is frequently an irritation for the employer who must compute taxes and possibly take more money from your bonus.
With the aggregate method, your bonus is taxed at the same rate as other earned income. The withholding rate is determined by your tax bracket. When taxes on wages plus bonuses are figured this way, your first tax payment might be higher.
The Exception To The Rules
The IRS will get a piece of any bonus you get. Even if your award is in cash, gift cards, a vacation, or some other benefit, it’s almost always necessary to pay taxes.
The exception to this rule is if your bonus may be considered an employee achievement award. You could be able to avoid paying federal income taxes under the following conditions:
- The prize isn’t cash, but rather a cash equivalent (such as a gift card or money order) or tickets to events, vacations, cruises, stocks, bonds, and other restricted items.
- The award is represented by a tangible object.
- The award is worth up to $1,600 in total.
How To File The Bonus On Your Federal Taxes?
The cash bonus amount should be recorded on the W-2 you receive in January. A cash incentive is taxed similarly to a salary and is reported on line 1 of Tax Form 1040 as such.
Employers may choose to utilize a federal flat rate of income tax, which is 22% for the whole year, on supplemental wages up to $1 million. However, any additional compensation exceeding $1 million is subject to a permanent 37 percent tax. Even if an employee claims exemption from federal income tax withholding on a Form W-4, the flat 37% rate applies.
State Taxes On Bonus
After you’ve figured out how much federal bonus tax and FICA tax you should take from the bonuses, you’ll want to figure out how much state bonus tax you’ll have to pay. This is usually the last tax in the procedure.
Bonus payments are subject to income taxes in most jurisdictions, although not all of them do. Some states even have varying bonus tax rates for distinct sorts of bonuses. The California state supplemental wage tax rate is 6.60 percent and rises to 10.23 percent on extra wages and stock options, for example. In Maryland, add in your local tax rate before calculating how much state bonus tax you must withhold. To figure out how much state bonus tax to withhold, consult a list of state bonus taxes.
Conclusion
Although bonus pay is taxable, it can still be a great way to reward employees for their hard work. Employers should take into account the taxes that will need to be deducted when determining how much to give as a bonus. By understanding the tax implications of bonuses, both employers and employees can enjoy the benefits of this type of supplemental wage.