Got a Bonus From Work? What You Need to Know About the Bonus Tax Rate

What we’ll cover:

• Bonuses have their own special tax withholding rules
• The amount that’s taken out depends, in part, on how your employer chooses to handle bonus payments
• Two common calculation methods are the percentage method and the supplemental wage withholding method

If you got a year-end bonus at work, nice job! It always feels good to be acknowledged (especially financially) for your hard work. 

Before you start plotting what to do with your bonus money, you may want to figure out how much will actually end up in your pocket after taxes. Yes, you read that right. Your bonus is subject to taxes. 

The amount that’s taken out for taxes is largely out of your control and depends, in part, on how your employer chooses to handle bonus payments. 

Hey, chin up. This shouldn’t make you any less thrilled about your bonus. We’ve got some information to help you understand how your bonuses may be taxed so that you’re better prepared when you actually see the bonus check. Grab a warm mug and settle in – there’s some math ahead.

How bonuses below $1 million are taxed

Employers are usually required to take (or “withhold”) a portion of an employee’s paycheck to pay taxes on his or her behalf. The amount that’s withheld is known as a withholding tax. Bonuses have their own special tax withholding rules because the IRS considers them to be “supplemental wages” instead of regular wages. To determine the withholding tax on bonuses, the IRS provides employers several calculation methods to choose from. Here are two common calculation options.

1. The Percentage Method (or flat-rate method). Under this approach, your employer withholds 22% of your bonus for federal income tax purposes. For example, let’s say you received a $1,000 bonus in your next paycheck. Your employer would withhold $220 from your $1,000 (22% x $1,000). 

2. The Supplemental Wage Withholding Method (or aggregate method). This approach is a little more complicated and involves several steps (bear with us).

• Let’s say your monthly base salary is $2,000 (paid on the first of each month), and your employer usually withholds $99 for federal income tax. 
• On the 15th of this month, your employer gives you a $1,000 bonus. 
• To figure out the amount to withhold from your bonus, using the aggregate method, your employer would add the $1,000 bonus to your regular base pay of $2,000. This brings your gross pay for the month to $3,000. Your employer would then check the IRS wage bracket tables to see how much they need to withhold from the $3,000. Let’s say the withholding amount is $217. Next, your employer would subtract the amount withheld from your most recent regular paycheck ($99) from the new combined withholding amount ($217), which comes to $118 ($217 - $99). 
• Your employer would withhold $118 from your bonus for federal income tax.

In the example above, the aggregate method resulted in a lower withholding tax. But this won’t always be the case, as each individual’s salary, bonuses and tax situation are different. Also keep in mind that the calculation methods are for determining your federal income tax withholding only. In addition to this, your employer usually has to withhold another portion for FICA taxes (Social Security and Medicare) and state and local taxes (if applicable). 

For bonuses over $1 million…

First of all, can we be friends? If you’re one of the lucky individuals whose bonuses exceed $1 million, your employer is required to withhold a little more for taxes. Let’s say you received a $1.5 million bonus – the amount up to $1 million is subject to a 22% federal withholding tax, and the amount over that ($500,000) is subject to a 37% tax (or the highest income tax rate for the year). So…

• $1,000,000 x 22% = $220,000 (withholding on first $1 million)
• $500,000 x 37% = $185,000 (withholding on amount over $1 million)
• $220,000 + $185,000 = $405,000 (total amount withheld from your bonus)

Just as with the previous example of bonuses below $1 million, if applicable, your employer might also withhold additional amounts for FICA, state and local taxes. 

Some parting thoughts on the bonus tax

It’s tough to give up a slice of your hard-earned bonus to taxes. But this is also a good reminder to talk to a tax professional to discuss ways you could offset the tax you pay on your bonus (think: tax deductions).  

Remember, contributions to certain savings accounts are generally tax deductible. Tax deductions can help lower your taxable income at the end of the year. Examples include contributions to Traditional IRAs and Health Savings Accounts (HSAs). 

If you got a big bonus, you may also want to spread the love. Certain donations (or “charitable contributions”) to qualified charities are tax deductible as well. Generally, the IRS limits how much you can deduct for charitable contributions to 50% of your adjusted gross income for the tax year. 

Keep in mind that many tax deductions come with eligibility requirements (e.g., income qualifications), so be sure to confirm the details with your tax preparer.