It's painful to be promised a bonus, only to get a paycheck for a much smaller amount than you were expecting because of the tax bite. Bonuses take many forms, including for attendance, performance, retention, referral, holiday or when you sign on as a new employee. Whether the bonus is taxable and should be included in your gross income depends on whether it is a cash or non-cash bonus.
TL;DR (Too Long; Didn't Read)
If you have received a cash bonus, you will be required to pay tax on it. However, non-cash bonuses may not accrue any tax obligations whatsoever.
Cash Versus Non-Cash
The Internal Revenue Service regards cash benefits as taxable. This includes cash bonuses, gift cards or certificates that have cash equivalents or are redeemable for merchandise, and charge cards or credit cards. Your employer must include the value of cash bonuses paid to you in your gross wages. Non-cash bonuses, also called “de minimis” benefits, are excluded from your gross income. De minimis means that the benefit is so small in value that it would be unreasonable and impracticable for your employer to account for it from an administrative standpoint. For example, bonuses given in the form of small gifts, concert tickets, gift baskets and meals would be considered de minimis. The IRS has previously ruled that items over $100 in value are not viewed as de minimis and are therefore taxable.
Understanding Federal Taxes
As of 2013, if your cash bonus is paid with your regular wages on the same check, your employer withholds federal income tax as though it were a sole payment for your regular payroll. As of 2017, employer would withhold federal income tax at a flat 25 percent if the bonus is paid as a separate check and the amount is $1 million or less. In 2018, the percentage reduces to 22 percent.
For amounts over $1 million, tax is withheld at the highest tax bracket level. In 2017, that was 39.6 percent and starting in 2018, that's 37 percent. Your employer withholds Social Security tax from your cash bonus at 6.2 percent up to $127,200 in 2017 and $128,400 in 2018, and Medicare tax at 1.45 percent.
If your total wages for the year, including cash bonuses, exceed $200,000 for a single filer, your employer must withhold an extra Medicare tax of 0.9 percent on the additional amount. The extra Medicare tax kicks in at $250,000 for married couples filing jointly and $125,000 for married people filing singly.
State Income Tax
State income tax withholding laws on bonuses vary by state. The state may apply a withholding rule that is similar to federal income tax, in which your employer withholds according to your state tax form or W-4 and the state withholding tax tables. Or it may require a flat amount or an incremental approach that depends on the bonus amount.
W-2 and Tax Filing
Your employer includes your cash bonus in your taxable wages on your yearly W-2 form. If the bonus is nontaxable, it does not show in your taxable wages on your W-2. If you received your bonus in the form of a taxable gift such as a free vacation, your employer should report the fair market value of the gift on your W-2. Your employer also puts the amount of taxes withheld from your bonus on the form. When you file your tax return, you include the taxable bonus amount in your gross income; this increases your adjusted gross income, upon which your income tax rate is based. To lower your tax liability, include on your tax return the taxes your employer withheld from your bonus.
Evaluating Employer-Paid Taxes
If your employer decides to "gross up" or pay the taxes for you, the bonus amount is included in your taxable income and the amount is reflected on your W-2. You still owe taxes on the bonus and the gross-up, but if the employer did the math right, you still come out ahead for the full amount of the bonus.
- IRS.gov: De Minimis Fringe Benefits
- IRS.gov: Circular E, The Employer's Tax Guide
- Social Security Administration: OASDI and SSI Program Rates & Limits, 2013
- IRS.gov: Questions and Answers for the Additional Medicare Tax
- The Motley Fool: Notice Your Bonus Was Taxed at a Much Higher Rate? Here's Why
- IRS: Early Release Copies of the 2018 Percentage Method Tables for Income Tax Withholding
- Social Security Administration: Contribution And Benefit Base
- IRS: Additional Medicare Tax