Getting a nice bonus from your employer is a welcome addition to your paycheck, but you might feel confused when you're trying to determine how taxes work for this type of income.
The Internal Revenue Service classifies bonuses and commissions as supplemental wages, and you may see bonus income listed separately on your paystub to reflect this. Your federal taxes for the bonus should correspond to the tax bracket into which you fall, but special withholding rules apply to bonuses. They often result in a smaller paycheck than you expected. The good news is that you might possibly get that money back as a tax refund after year's end.
Take a look to learn more about bonus tax withholding and tax calculation for regular and bonus income.
Learning About Employee Bonuses
Your employer might provide you with a one-time or recurring bonus for a variety of reasons. You might receive one to celebrate a major holiday or to commemorate reaching a company goal or showing excellent performance. Some employers offer ongoing gain-sharing and profit-sharing bonuses to motivate workers to excel for the company, while others provide one-time sign-on and referral bonuses to offer perks to new hires and current employees who recommend them. Commissions based on sales are also common.
Understanding Taxes on Income
Both regular wages and bonus income are subject to the same types of taxes such as federal income tax: Social Security Tax and Medicare tax, then you can have state and local income taxes as well that vary based on location.
You can expect to pay 6.2 percent in Social Security taxes on up to $147,000 of your wages in the 2022 tax year. Your employer will pay the same amount to reach a total of 12.4 percent. This wage limit, referred to as the "contribution and benefit base," changes every year. It was $142,800 in 2021.
Your Medicare tax rate as an employee is 1.45 percent, with your employer paying the same for a total of 2.9 percent. There's no base or wage limit for Medicare. An extra 0.9 percent Additional Medicare Tax will also apply if you earn more than $200,000 during the year, or $250,000 if you're married and filing a joint tax return.
Federal income tax rates change annually. They depend on your income and filing status. They're set at brackets of 10, 12, 22, 24, 32, 35 and 37 percent as of 2022. Certain segments of income are taxed at different rates. For example, your income from $10,275 up to $41,775 is taxed at 12 percent in the 2020 tax year, while your income from $41,775 up to $89,075 is taxed at 22 percent. This is known as a progressive tax. You're taxed at a higher rate as you earn more. These income spans also adjust annually for inflation.
Federal tax is based on the adjusted gross income calculated on your tax return. You can find your AGI on line 11 of your 2021 Form 1040 tax return. It's arrived at after adding up all your sources of income and deducting some adjustments to income which effectively act as tax deductions.
Exploring Basics of Tax Withholding
Your employer uses the information you've provided on IRS Form W-4, the Employee's Withholding Certificate, to determine the amount of taxes that should be withheld from your pay. This document tells them about your intended filing status, number of dependents, other income, expected deductions and any extra taxes you want to be withheld.
Your employer can take the information and either use withholding tables provided by the IRS or use a more complex percentage method to try to withhold the right amount of taxes out of your pay.
Considering Bonus Tax Withholding Differences
Your bonus income may be subject to different withholding treatment than your regular income depending on how much the bonus is and what your employer prefers to do in certain cases.
The regular withholding rate based on your W-4 will apply if your bonus amounts to no more than $1 million and if your employer doesn't separate your "supplemental" bonus and regular wages, or if they decide to combine both wages during that pay period using something called the aggregate method. Otherwise, your employer can use the percentage method to withhold 22 percent from your bonus income. So you might be in the 12 percent tax bracket for your regular income, but a $5,000 bonus would mean $1,100 withheld if this flat rate is used. A $20,000 bonus would mean $4,400 withheld. No other percentage is permitted.
Your employer must withhold a flat rate of 37 percent if your bonus surpasses $1 million. A $1 million bonus would have $370,000 withheld, while a $2 million would have $740,000 tax withheld.
Calculating Your Income Taxes
The amount of bonus tax withheld doesn't necessarily reflect the tax bracket you're in or the taxes you'll owe at the end of the year, so it helps to take a look at an example of federal, Medicare and Social Security tax calculation so that you know what to expect. Keep in mind that there are plenty of factors such as additional types of income, as well as deductions and credits that can impact the final result.
Consider that you're a single taxpayer who receives $50,000 in regular wages and $5,000 in bonus wages in 2022. You have no other sources of income. You're claiming no credits or tax deductions besides the $12,950 standard deduction for your single filing status. Here's what the tax breakdown would look like:
- Your combined gross income would be $55,000 and subject to the 6.2 percent in Social Security and 1.45 percent in Medicare taxes. This would mean $3,410 for Social Security and $797.50 for Medicare for a total of $4,207.50 in these taxes.
- Subtracting the $12,950 standard deduction from your $55,000 gross income gives you taxable income of $42,050. This puts you in the 22 percent tax bracket as a single filer on your top dollars.
- You're taxed at the rate of 10 percent on the first $10,275, or $1,027.50.
- You're taxed at the rate of 12 percent on your income from $10,275 to $41,775, or $3,780.
- You're taxed at the rate of 22 percent on your income from $41,775 to $42,050, or $60.50.
- Your total tax bill is $4,868 ($1,027.50 + $3,780 + $60.50.
State and local taxes may also apply in addition to this federal income tax, so research those tax rates to find out how they might add to your tax bill.
Reporting Bonuses on Tax Returns
The good news is that you don't have to do anything special when it comes time to report your regular and bonus income on your tax return. The IRS asks that your employer report both regular and supplemental wages combined in boxes 1, 3 and 5 on the W-2 form you receive early in the year. This income will go on line 1 of your Form 1040 along with any other wages and tips you might earn from other jobs where you're an employee.
Taking Advantage of Tax Deductions
The key is to take advantage of any tax credits and deductions for which you might be eligible so you pay the least taxes on your regular and bonus income. Look into whether you qualify for:
- Educational tax credits such as the Lifetime Learning Credit and American Opportunity Tax Credit
- State, local, property and sales tax deductions (itemized)
- Retirement plan contribution deduction and saver's credit
- Home office and business expense deductions for the self-employed
- Charitable donations deduction (itemized, except for up to $300 in cash donations made in 2020)
- Earned income and child tax credits
- Mortgage interest deduction (itemized)
- Student loan interest deduction
And keep in mind that your bonus won't actually be taxed at that 22 percent rate if your taxable income is such that your top tax bracket is only 12 percent: Your total income did not surpass the $41,775 threshold, pushing it into the 22-percent range. That's a difference of 10 percent that you'll get back as a refund after you file your return. Withholding is subject to the 22 percent rate, but you'll only owe 12 percent on that money when you file your tax return because that's your top tax bracket.
- IRS: 2022 Form W-4, Employee’s Withholding Certificate
- Tax Foundation: The Three Basic Tax Types
- IRS: Topic No. 751 Social Security and Medicare Withholding Rates
- IRS: General Instructions for Forms W-2 and W-3 (2021)
- IRS: 2021 Form 1040 U.S. Individual Income Tax Return
- IRS: Questions and Answers for the Additional Medicare Tax
- Tax Foundation: 2022 Tax Brackets
- IRS: Publication 15 (2022) (Circular E) Employer's Tax Guide
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree, bookkeeping certification and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include Zacks, JobHero, LoveToKnow, Bizfluent, Chron and Study.com.