Posted by Abundant Wealth Planning LLC

How Bonuses Are Taxed

How Bonuses Are Taxed

Quite a lot of companies hand out bonuses as rewards and incentives for work done through the years. Employees that have contributed their quota towards the advancement of the firm deserves such. To the IRS, however, the bonus is classified as an income hence subjected to income tax. This article explores the tax on bonus income.

  

State and Federal Taxes

Even though Uncle Sam slams your bonus with the income tax, it is not taxed at the top marginal rate. Bonus is a supplemental income that is taxed at a withdrawal rate of 22%

Example: For someone that got $5,000 as a bonus for the year, this person will likely have $1,100 withheld and sent to the IRS as a bonus tax. ($5000 x 0.22 = $1,100)

While there could be state taxes on your bonus as well, the withholding rate varies, as it is a factor of the state. 

Qualifying and receiving a big bonus (over $1M) might attract a higher tax rate. For the first million, the 22% federal tax rate stands and 37% for what is left after the first million.

Example: Samantha got $2.5 million as a bonus, he will pay $775,000 as total tax

First $1M = $1,000,000 x .22 = $220,000

The Remaining $1.5M = 1,500,000 x .37 = $550,000

$220,000 + $555,000 = $775,000 total tax for Samantha


Meeting Your Tax Liabilities

In sending your bonus tax to the IRS, your employer might choose to go with any of two options: The percentage method or the aggregate method. 

  • The percentage method is relatively straightforward. Your employer withholds the rate (22% or 22% and 37% for higher bonus) specified above, depending on your bonus.

  • The aggregate method:  in case your employer pays the bonus together with your regular salary, and the entire amount will be used to calculate the withholding. For a person that uses 28% as the withholding amount for income taxes, the bonus will also have the same rate as withholding.

Bear in mind that using the aggregate method will not subject you to excessive tax on your bonus. Even if you withhold too much on your bonus, Uncle Sam will likely send you a refund. It is also not a license to see less of the cash upfront judging from the bonus. 

With this, you can estimate just exactly how much you will send to Uncle Sam as a tax on your bonus. Either the percentage method or the aggregate method can guide you depending on what you prefer.

Reducing Your Tax Liabilities

We know it sucks to have to send such an amount of money to the IRS. Sadly, there is no way to outsmart the government and avoid paying tax on your bonus. There is an intelligent suggestion to use your bonus and reduce your tax liability over time. 

Directing the money either to your Individual Retirement account or your ROTH makes a lot of sense. 

For people that will have to take a pay cut in the following year (people ready to retire, for instance,) you can request that your employer defer your bonus till the next year. It can reduce your entire tax liability.



Abundant Wealth Planning LLC
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