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December 15, 2020
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.
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).
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).
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…
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.
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.
This article is for informational purposes only and is not a substitute for individualized professional advice. Individuals should consult their own tax advisor for matters specific to their own taxes and nothing communicated to you herein should be considered tax advice. This article was prepared by and approved by Marcus by Goldman Sachs, but does not reflect the institutional opinions of Goldman Sachs Bank USA, Goldman Sachs Group, Inc. or any of their affiliates, subsidiaries or division. Goldman Sachs Bank USA does not provide any financial, economic, legal, accounting, tax or other recommendation in this article. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice. Information contained in this article does not constitute the provision of investment advice by Goldman Sachs Bank USA or any its affiliates. Neither Goldman Sachs Bank USA nor any of its affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of the statements or any information contained in this document and any liability therefore is expressly disclaimed.