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Year-End Bonus Taxes: What Are They And How They Reduce Bonuses

Tax on Bonuses
Tax on Bonuses

To put it simply, bonuses are considered taxable income which is why they are taxed. In this article, read and find out about the different taxes that reduce year-end bonuses!

Bonus Payments [Photo: Shouse Law Group]

Bonus Payments [Photo: Shouse Law Group]

Bonuses are considered taxable income, thus, they are taxed. However, the Internal Revenue Service (IRS) can also consider bonuses as supplemental wages which are not regular wages. When an employer pays supplemental wages, payroll tax rules must be followed. This means the bonus, a portion of the wages, must be withheld for taxes.

According to Taylor, the amount that is withheld from a bonus will base on the withholding method the employer used. The method in turn will base on the amount of the bonus and how the bonus was paid. Reportedly, there are two different methods that withhold taxes on supplemental wages.

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Percentage Method

According to Taylor, the percentage method is commonly used when a bonus check is issued separately from the normal paycheck. In the percentage method, if the bonus is less than $1 million, 22% of the bonus will automatically be withheld for tax. On the other hand, if the bonus is more than $1 million, 37% of the amount that exceeds $1 million will be withheld. 37% corresponds to the top federal income tax rate.

Aggregate Method

The aggregate method is commonly used when the bonus is paid along with the regular pay in a single payment. The employer will withhold tax according to the formula based on the information provided on the employee’s W-4 Form. However, since the bonus and the regular pay are combined as a lump sum, the amount of tax is higher. In addition, normal income and payroll taxes such as state and Social Security taxes are also withheld.

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