How Your Year-End Bonus Is Taxed (2024)

FAQs

How Your Year-End Bonus Is Taxed? ›

Bonuses are taxable income, but the IRS considers them supplemental wages, which means taxes may be withheld on your bonus differently than they are on your ordinary wages. Employers can either tax your bonus at a flat 22% rate or use a more complex withholding calculation.

The federal bonus tax rate is typically 22%. However, employers could instead combine a bonus with your regular wages as though it's one of your usual paychecks—with your usual tax amount withheld. There are ways to reduce the tax impact of your bonus.

Why is tax withholding on bonuses so high? Since bonuses are paid in addition to your normal paycheck, taxes are withheld at a higher rate than your regular wages.

“If they just raise our salary, we're not going to be taxed so heavily on that. Plus there's no guarantee year-to-year what they're going to do,” she said. Bonuses can be taxed at a higher rate than normal wages, though there are some ways to mitigate that, and you might wind up getting a refund.

Your bonus will be taxed, but you can lower the amount of your taxable income by depositing some or all of it in a tax-deferred retirement account such as a 401(k) or IRA. However, this does not mean you will avoid paying taxes completely.

One of the most common end-of-year bonus delivery methods is cash or check from your employer. If your employer does this, the bonus amount should be added to the W-2 you receive in January. A cash bonus is treated similarly to wages, and is taxed as such. You will report the bonus as wages on line 1 of Tax Form 1040.

The withholding rate for supplemental wages is 22 percent. That rate will be applied to any supplemental wages like bonuses up to $1 million during the tax year. If your bonus totals more than $1 million, the withholding rate for any amount above $1 million increases to 37 percent.

Like regular pay, bonuses are subject to both federal and state tax.

Can I give my employee a tax free bonus? ›

Since the IRS views bonuses as supplemental income, employers must withhold taxes on bonuses according to IRS regulations for supplemental income, which is a separate withholding calculation than your regular wage or salary pay.

Key Takeaways

A bonus or windfall can represent a great way to jumpstart your retirement savings, especially if you're allowed to use your bonus to make a special contribution, it might make very good sense to use the extra cash to maximize your 401(k) contribution.

When your employer provides you with a bonus, they will report it on your W-2 in box 1—but it's combined with your normal wages or salary. In the eyes of the Internal Revenue Service, your bonus is no different than the salary you receive.

First and foremost, bonuses are taxed because they are considered taxable income. But the IRS also considers bonuses to be supplemental wages. Essentially, supplemental wages are types of wages, e.g., overtime, commissions, etc., that aren't regular wages.

Bonuses are taxable income, but the IRS considers them supplemental wages, which means taxes may be withheld on your bonus differently than they are on your ordinary wages. Employers can either tax your bonus at a flat 22% rate or use a more complex withholding calculation.

Changing your tax withholding for a pay period is always an option, but you should make sure that you have the right information to ensure that your reporting goes as smoothly as possible. The withholding on the W-4 affects your entire paycheck, not just the bonus.

A bonus is taxed using a percentage method or an aggregate method. The flat tax rate for a bonus is 22%. You can minimize your tax burden by having your employer withhold taxes from each paycheck above your tax bracket, utilizing all available deductions, and taking advantage of qualified investments.

In many locations, cash and cash equivalents are considered as a form of compensation, meaning they are taxable — regardless of the amount. This can also apply to gift cards, gift certificates, and prepaid cards, which are often considered benefits in kind.

Remind students that wages, salaries, bonuses, commissions, and tips are taxable. Employers report these types of income on Form W-2, Wage and Tax Statement. Remind students that ALL tip income is taxable, even if it is not reported on Form W-2.