How a Holiday Bonus is Taxed

How a Holiday Bonus is Taxed

What is a holiday bonus?

Holiday bonuses are extra money companies give their employees at the end of the year. Some companies award bonuses based on individual employee performance. Other companies offer bonuses based on a percentage of each employee's salary, and others offer a set dollar amount to all employees, regardless of salary.

What is the average bonus?

According to the Accounting Principals Holiday Bonus and Hiring Survey, bonus payouts increased by 66% in 2017. In 2016, the average bonus was $1,081, and in 2017, the average rose to $1,797. As the monetary value of bonuses increased, the likelihood of receiving them decreased. In 2016, 75% of HR managers said their company offered employees cash vacation bonuses, while in 2017, only 63% of HR managers said their company offered them.

Employees working in certain industries are more likely to receive a vacation bonus than employees working in others. According to a CNBC article, the employees who typically receive the biggest holiday bonuses are in the energy and mining industry, computer hardware, IT services, consumer goods, and financial industry. The analysts arrived at these conclusions by studying the average bonus value reported for all jobs with at least 40 compensation reports.

In 2015, Houston-based energy company Hilcorp made headlines when it offered each employee a $100,000 bonus. While Hilcorp employees certainly had a great holiday season, it goes without saying that such generous bonuses are far from typical.

Why don't employers give bonuses?

According to accounting managers, the most common reason employers choose not to award holiday bonuses was that they provided other benefits to employees. Other organizations made charitable donations on behalf of employees rather than a direct bonus. Human resources and employment managers said the best ways for employees to increase their chances of receiving a bonus was to stay motivated throughout the year, stay positive, take on extra tasks, remind the company of their accomplishments, and ask their boss directly for a bonus.

Holiday bonuses and taxes

Although receiving a large sum of money from the employer may seem like a gift, legally, it's just another form of income that the government can tax, so if you get a $1,500 bonus, you shouldn't plan on spending everything. The following tax rates apply to bonuses earned:

  • Contributions to a pension plan: If you have chosen to withhold part of your salary to contribute to a pension plan, the same percentage of your premium is likely to be withheld and paid into your plan. Although keeping the bonus money gives you less money to benefit from upfront, it will help you build an even bigger nest when it's time to retire.

  • Federal income tax: This tax is a little more complicated than other forms of taxation. The IRS generally requires you to withhold 25% of your additional income, including bonuses. Still, your company has the option of combining your bonus with your regular pay, which will often result in an additional withholding. If this happens, it may work in your favor - the additional tax rates may be higher than your total tax rate at the time of filing, so you may be able to recoup some of the money withheld as part of your tax return. 

  • Medicare Tax: All payments are Medicare taxable, so expect 1.45% of this tax to be deducted.

  • Social Security Tax: If you haven't earned $145,000 in income this year, your employer will deduct 6.2% of your Social Security premium.

  • State Income Tax: This amount varies by state, so check your local policy before setting aside additional funds. In New York, for example, you can expect to pay 4-8% more if you live within New York City limits.

Higher salary or Bonus? Which is better?

If you have the option of receiving a higher salary or a vacation bonus, there are pros and cons to choosing one of the two options. In general, companies benefit more from bonuses given to employees than from salary increases because the bonus is only given once, so there is less commitment.

Another benefit for employers is that offering performance-based bonuses can encourage employees to stay motivated and do their best. A disadvantage of employers offering bonuses is that employees can expect regular vacation bonuses and may become unhappy if a company has a bad year, leading to lower bonuses or no bonus.

For employees, earning an additional fixed amount can be a good way to increase their savings because it's easier to separate from regular pay. Receiving a bonus can help provide great holiday gifts, but earning a higher salary can lead to better rewards later. A disadvantage of receiving a bonus instead of a raise is that the amount is not included when considering the full pension or unemployment amount.

If you receive a performance bonus, it may be paid at the next performance review, when you have the opportunity to mention the results. Being able to show that your hard work has brought tangible rewards can help you negotiate a higher salary down the road.



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