Posted by Income Taxes and Bookkeeping LLC

Bonus Tax Rate: How the IRS Tax Bonuses

Bonus Tax Rate: How the IRS Tax Bonuses

No one dislikes a bonus as it presents a bump in your pay. Uncle Sam also wants its share of the cut unknown to most people. However, the taxation of bonuses is different from regular income. You will not add the bonus to your ordinary income as Uncle Sam classifies it as supplemental wage. As a result, there is a flat 22% federal withholding rate on bonus. 

This article will shed light on the taxation of bonuses:

Supplemental wages

According to Uncle Sam, all bonuses are classified as supplemental wages. Uncle Sam reveals that this is any money paid to a worker that is not part of their regular wages. 

As a result, all kinds of bonuses, severance pay can be classified as supplemental wages. Other examples are:

  • Payment for overtime

  • Back pay

  • Award

  • Some commissions

  • Accumulated sick leave

  • Retroactive pay increase

  • Awards and prizes

  • Tips reported, etc. 

Taxation of Bonuses 

In the same way, an employer needs to withhold some of your regular paychecks; they also need to hold some money back from your bonus. Such funds are also sent to Uncle Sam as tax withholding. 

There are two ways to calculate tax withholding – the percentage method or the aggregate method.

The Percentage Method 

Also known as the flat rate method, it is the easiest way to estimate the tax on a bonus. This method initially puts more money in your pocket. 

The bonus is identified separately from the entire regular wage by this method. Such supplemental wage has a withholding rate of 22%, which will be applied to all additional wages in the tax year – bonuses up to $1 million. For bonuses that are more than $1 million, the withholding rate rises to 37%.

There is also a social security tax (also called FICA) and Medicare tax, alongside the 22% federal tax. Depending on your state of residence, there could also be state income tax. 

Social Security with medical tax has a combined tax rate of 7.65%.

For employees, the social security tax rate is placed at 6.2%. Your first $142,800 will be subjected to FICA taxes for 2021. It is called the social security base limit. In 2020, the limit was placed at $137,700. In 2022, there will be a provision that will tax income above $400,000 which will create the "donut hole." Income between $142.800 and $400,000 will not be taxed. 

On the other hand, Medicare tax has a rate of 1.45% with no wage base. However, an extra 0.9% is for people who earn above $200,000 each year. 

The Aggregate Approach

There are times employers offer a bonus with their regular wages. For this case, the employer needs to use the aggregate approach to estimate the initial tax withholding on the bonus. This result most times is a disturbance for the employer who is evaluating the tax withholding and has more money withheld from the employee's bonus. 

The aggregate method allows the tax withholding for the bonus to be estimated at the average income tax rate. Such withholding rate is a factor of one's tax bracket. In many cases, when the taxes on bonus alongside the wage are estimated together, the initial tax withholding is usually higher. 

It doesn't end at tax withholdings.

Your employer's approach can have a severe impact on the amount that eventually ends up with you. However, your entire debt to Uncle Sam will be unclear until you file the tax return for the coming year. 

If you have a pretty high tax withholding, there might be a refund from the IRS for the extra payment. Similarly, if you have little money withheld, you might need to send more money to Uncle Sam. 

An excellent way to reduce the risk of owing Uncle Sam is to explore the withholding on your W4. Uncle Sam's tax withholding estimator is a perfect tool to guide you. People who got a large bonus might be better off discussing with a tax pro for advice. 



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