Bonus Tax Rate: How Are Bonuses Taxed, Who Pays?
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Earning a bonus can feel like a well-deserved reward. After all, who doesn't want a pat on the back, plus some extra cash? But you might be in for a surprise when your paycheck arrives, and you ask yourself, “Wait a minute — why are bonuses taxed so high?"
Here’s a guide to how bonuses are taxed, the two methods employers can use to calculate your withholding, and some tips for minimizing the tax impact of a bonus.
What is a bonus?
A bonus is a form of additional compensation awarded to a worker at a company's discretion. Bonuses are usually lump sums that are paid out in addition to a worker's existing salary or wages.
Bonuses are often distributed on special occasions (such as a holiday) or built into certain compensation plans (achieving an annual sales goal, for example). Other bonus types include annual, merit, referral, sign-on and retention bonuses.
Bonus tax rate 2024
The IRS considers bonuses supplemental wages. This means that bonuses are taxed at 22%, with any amount over $1 million being taxed at the highest federal tax rate of 37%.
In addition to federal withholding, you likely will need to have taxes withheld for Medicare and Social Security (also called FICA taxes), and you may have to pay state taxes on the bonus as well.
The "supplemental wage" category also includes overtime pay, commission, severance, back pay, retroactive raises, tips, awards, prizes, payments for nondeductible moving expenses and payments for accumulated sick leave.
How are bonuses taxed?
Taxes on your bonus can be withheld on your paycheck in one of two ways: the percentage method or the aggregate method. The percentage method taxes your bonus at a 22% rate. The aggregate method is more complex and involves adding your bonus to your regular paycheck and taxing the total.
» Need to back up? How tax withholding works
When it comes time to file your annual taxes, your total earned income — including your bonuses — will be combined and listed in Box 1 of your W-2. If you've had enough withheld throughout the year, you may not have a tax bill. If you've withheld too much or too little, that might mean a tax refund or a bill.
Are bonuses taxed differently?
Yes. 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 percentage method
If you receive a bonus separately from your regular paycheck, your employer is probably using the percentage method to calculate how much tax to withhold on your bonus. Here's how that works:
Your total bonuses for the year get taxed at a 22% flat rate if they're under $1 million.
If your total bonuses are higher than $1 million, the first $1 million gets taxed at 22%, and every dollar over that gets taxed at 37%. Your employer must use the percentage method if the bonus is over $1 million.
Example 1 | |
Ryan receives a $2,000 bonus. That bonus gets taxed at 22%, resulting in $440 of the bonus being withheld for federal taxes. | $2,000 x 0.22 = $440. |
Example 2 | |
Julia receives a $1.5 million bonus this year. The first $1 million gets taxed at 22% and the remaining $500,000 gets taxed at 37%, resulting in $405,000 withheld for federal taxes. | $1,000,000 x 0.22 = $220,000 $500,000 x 0.37 = $185,000 $220,000 + $185,000 = $405,000 |
Pros: The benefit of this percentage method is that it's relatively easy for the employer, so you'll often see taxes withheld this way on bonuses.
Cons: The disadvantage of this method is that most people's effective tax rate is not 22%. If you're in a higher tax bracket, there's a chance that not enough of your bonus was withheld for taxes, which can lead to a surprise tax bill at the end of the year. On the other hand, if you're in a lower federal tax bracket, your bonus might get taxed at a higher rate than your regular income. That means more of your bonus will be withheld, but you might get a tax refund when you file.
The aggregate method
The aggregate method, or wage bracket method, is the second way employers can calculate taxes withheld on a bonus. This often occurs when your employer lumps your bonus and regular wages into one paycheck. Here's how that works:
Your bonus and your regular income/wages are combined into one paycheck.
Your payroll department will withhold taxes on the entire aggregated payment at the same rate. That withholding rate depends on your filing status and the information you provided on your W-4.
Example | |
Michael’s filing status is single. His regular biweekly wages are $2,000. During this pay period, he also received a $550 bonus, which his employer added to his regular income. According to the IRS' wage bracket withholding table, Michael's $2,550 paycheck triggers a standard withholding of $243. | $2,000 (regular wages) + $550 (bonus) = $2,550 total biweekly earnings. |
Pros: While it's not perfect, the aggregate method has a better chance of ensuring that you're withholding enough to cover your tax liability. Translation: There’s a smaller chance of a surprise tax bill because of your bonus.
Cons: It requires more work for the employer to calculate — and it's still possible to withhold too much, which could mean a bigger bite out of your paycheck than necessary. But, on the bright side, it gives you a better chance of having an accurate withholding for the year, or possibly a refund.
How to minimize the tax impact of a bonus
1. Review your W-4
Because bonuses can occur at any point during the year, they get added to your salary piecemeal. And that can inflate your earnings or even push a portion of your income into a new tax bracket, increasing your tax liability.
Before or after your bonus is paid out, it could be worth doing a little maintenance on your W-4 form to adjust your withholdings. Figuring how much to withhold can be tricky, but our W-4 calculator can help you understand whether you're on the track to owe, get a refund, or zero-out your tax liability.
» MORE: How to adjust your W-4
2. Make sure your bonus is actually taxable
Make sure that the bonus you're getting is actually ... a bonus. The IRS has rules about what it considers taxable. Things such as occasional tickets for events, holiday gifts, money for meals while working overtime, flowers, books, and other intermittent low-value fringe benefits are generally considered nontaxable. But once your employer forks over cash, offers you a gift card or hands over a high-value gift, things get murkier. Check with a CPA or other tax professional if you're unsure about the tax implications of a gift or an award.
3. Use tax deductions
Tax deductions are one of the best-known ways to lower your taxable income and help you offset some of your tax liability. Most taxpayers take the standard deduction, but if your individual tax-deductible expenses — such as unreimbursed medical costs, donations or mortgage interest — add up to more than the standard deduction, itemizing can help you trim your taxable income and save on your tax bill.
4. Contribute to a tax-advantaged account
As far as tax-mitigation strategies go, this one might be a win-win for most folks.
If you haven’t hit your yearly contribution limit on a tax-advantaged plan, such as a 401(k), an HSA or a traditional IRA, consider using your bonus toward a qualifying contribution. Because the money you put into these accounts is pre-tax, it can lower your taxable income while also putting your hard-earned paycheck toward a long-term savings goal.
» MORE: See our picks for the best IRA accounts
5. Defer your bonus
Some people might also ask their employer to defer the bonus until the following year. Importantly, doing so does not eliminate the taxes owed — it merely defers the payment of taxes until a later date. This strategy could make sense if:
You think your bonus will push a portion of your income into a higher tax bracket, and you need extra time to save up for the taxes you might owe.
You think your total income next year will be lower than the current year, which might lower your tax liability.
Because this can be a tricky strategy to navigate, consider consulting a CPA or another tax professional to ensure it's the right call for your financial picture.
» Ready to get started? Here's how to find the best CPA near you
Taxes on bonuses: The bottom line
Neither tax withholding method is an exact science, so keep an eye on your total withholdings for the year if you get a bonus. If you have a sense of what your total income will be, you can tinker with your W-4 and adjust your withholding to get out ahead of things before tax time.
