How Bonuses Are Taxed

If you’ve recently received a bonus or are about to, you may be surprised at how much your employer withholds for taxes. However, you won’t necessarily pay the amount that’s withheld when all is said and done.

Here’s a closer look at how bonuses are taxed and how to plan for one.

How Are Bonuses Taxed?

At the end of the year, any bonus you receive from an employer will be added to your wages, tips and other compensation. The total will be taxed according to the federal income tax rates that apply to you for that year.

For example, if you’re a single filer who earned $75,000 in regular wages and a $10,000 bonus in 2023, you’d pay:

• 10% on the first $11,000 ($1,100).
• 12% on the next $33,725 ($4,047).
• And 22% on the next $40,275 ($8,860.50).

The total amount of federal income tax due on your $85,000 income would be $14,007.50. Additionally, you’d be responsible for your share of Social Security tax (6.2%), Medicare tax (1.45%) and any state or local income taxes that apply where you live.

While that may sound like a big check to write, you don’t pay it all at once. Instead, your employer withholds a portion from each of your paychecks and sends it to the IRS. When you file, you’ll get a refund if you overpaid or a bill if you underpaid.

How Does Tax Withholding Work on Bonuses?

The way your employer will withhold taxes from your bonus will depend on the situation and whether they use the percentage or aggregate method.

Bonus Tax Rates With the Percentage Method

When employers use the percentage method, they withhold a flat percentage of your bonus and any other supplemental wages you earn. This method is an option for your employer if:

You’ve received less than $1 million in supplemental wages in a calendar year, and;

Your supplemental wages are identified as separate from your regular wages, and;

Your employer has withheld income tax from your regular pay in the current or preceding year.

When these conditions are met, your employer can opt for the percentage method and withhold 22% of your bonus and other supplemental wages. For example, if you received a $10,000 bonus, it would withhold $2,200.

If you receive more than $1 million in bonuses and other supplemental wages during a single calendar year, the IRS requires your employer to withhold 37% (or the highest rate of income tax for the year) of the amount above the $1 million mark.

Bonus Tax Rates With the Percentage Method:

• $1 million or less: 22%.
• Over $1 million: 37%.

While the percentage method is often the easiest for employers to use, it can cause some issues for you as the employee.

“The high withholding rate results in a large tax refund for employees with effective tax rates below 22%. While this might sound good, many of those employees need the money during the year to cover their bills,” says Beth Logan, an enrolled agent based in Massachusetts.

“If the employee has an effective tax rate above 22%, but doesn’t earn $1 million in supplemental wages, then they often end up owing a lot of money when they file their tax return. Unfortunately, taxpayers can be hit with interest penalties if they owe more than $1,000,” Logan says.

Bonus Tax Rates With the Aggregate Method

The second withholding option is called the aggregate method. When employers take this route, they withhold federal income tax as if your bonus and regular wages for a payroll period are a single payment. Employers use worksheets and withholding tables provided by the IRS to figure out how much to withhold.

This method is an option when you receive less than $1 million in supplemental wages in a calendar year, your bonus is separately identified from regular wages and you’ve had your pay withheld by your employer in the current or preceding year.

On the other hand, the aggregate method is mandatory if:

Your employer hasn’t withheld income tax from your regular wages in the current or immediately preceding calendar year, or;

If your bonus or another type of supplemental wage is paid but the amount isn’t differentiated from your regular wages.

So, what does the aggregate method mean for you?

“It often results in more money being withheld from your bonus. While that doesn’t mean you’ll pay more tax in the end, it does mean that you’ll often see less of your bonus upfront,” says Levon L. Galstyan, a CPA in Los Angeles.

Tax Planning Tips

While bonuses provide you with a lump sum of extra cash, they can have an undesirable impact on your tax bill. Depending on where your annual income sits, a bonus could bump you up to a higher tax bracket.

If you want to lower your taxable income, you have a few options.

“You can use your bonus to increase your contributions to your health savings accounts or retirement funds like 401(k)s or traditional IRAs,” Galstyan says.

“You might also be able to discuss your bonus with your employer and push it to a subsequent year,” says Jeffrey Wood, a financial advisor at Lift Financial in Utah. “This can offer an advantage if your earnings are expected to be lower in the following year.”

Beyond lowering your taxable income, it’s important to keep an eye on your tax withholdings to ensure they’re set up to benefit you.

“You can always request your payroll department or company submit an updated W-4 form to ensure that you’re withholding enough for taxes, but not too much. While some prefer to have a large refund come tax time, others might prefer not to provide an interest-free loan to the government throughout the year,” Wood says. You also don’t want to end up with a big surprise bill and underpayment penalties.