Getting a nice bonus from your employer is a welcome addition to your paycheck, but you might feel confused when determining 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. While your federal taxes for the bonus should correspond to the tax bracket in which you fall, special withholding rules apply to bonuses and usually mean a smaller paycheck than expected. 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 you on 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, and then you can have state and local income taxes as well that vary based on location.
For the 2020 tax year, you can expect to pay 6.2 percent in Social Security taxes on up to $137,700 of your wages, with your employer paying the same amount to reach a total of 12.4 percent. Note that this wage limit usually changes every year. Your Medicare tax rate as an employee is 1.45 percent with your employer paying the same for a total of 2.9 percent, but an extra 0.9 percent Medicare tax will start applying if you make over $200,000 during the year.
The federal income tax rates change annually, depend both on your income and filing status and currently include brackets of 10, 12, 22, 24, 32, 35 and 37 percent. Certain amounts of income will be charged in different brackets depending on your tax situation, and federal tax is based on the adjusted gross income calculated on your tax return. For example, a single person with an AGI of $30,000 would pay 10 percent on the first $9,875 and 12 percent on the remainder. However, a married person filing jointly with the same $30,000 AGI would pay 10 percent on the first $19,750 and 12 percent on the remainder.
Exploring Basics of Tax Withholding
Normally, your employer uses the information you've put on IRS Form W-4, Employee's Withholding Certificate, to determine the amount of taxes they should collect over the year. This document will inform 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
When it comes to withholding, your bonus income may have different treatment than your regular income depending on how much the bonus is and what your employer prefers to do in certain cases. However, you should keep in mind that your actual tax obligation for the year shouldn't differ just because your employer takes more taxes out during that pay period than usual. In some cases, you might even get some of the extra withheld money back at tax time.
If your bonus amounts to no more than $1 million, the regular withholding rate based on your W-4 will apply when your employer doesn't separate supplemental 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 25 percent from your bonus income. So, while you might be in the 12 percent tax bracket for your regular income, a $5,000 bonus would mean $1,250 withheld if the flat rate is used and a $20,000 bonus would mean $5,000 withheld.
If your bonus surpasses $1 million, your employer must withhold a flat rate of 37 percent. So, a $1 million bonus would have $370,000 withheld, while a $2 million would have $740,000 bonus tax withheld.
Calculating Your Income Taxes
As you've seen, 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 more of what to expect. However, you'll want to 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.
For this simple scenario, you'll consider that a single taxpayer received $50,000 in regular wages and $5,000 in bonus wages, and they have no other sources of income. They are claiming no credits or tax deductions besides the $12,400 standard deduction for their filing status in 2020. Here's what the tax breakdown would look like:
- The taxpayer's 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 to get a total of $4,207.50 in these taxes.
- Subtracting the $12,400 standard deduction from the $55,000 gross income gets you an AGI of $42,600. The $42,600 AGI puts the person in the 22 percent tax bracket and leads to $5,162 in federal taxes owed.
Along with these federal taxes, keep in mind that state and local taxes may also apply. So, you'll want to research those tax rates and see how they might add to your tax bill.
Reporting Bonuses on Tax Returns
When it comes time to report your regular and bonus income on your tax return, the good news is that you don't need to do anything special in the situation. 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 once added to other wages and tips you might earn from other jobs where you're an employee.
Taking Advantage of Tax Deductions
To pay the least taxes on your regular and bonus income, the key is to take advantage of whichever tax credits and deductions for which you might be eligible. Note that while some require forgoing the standard deduction to itemize instead, others don't have this requirement. Here's a list of some of the most common ones to look into:
- 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
- Salary.com: Types of Bonuses: 10 Bonus Programs for Employees
- Credit Karma: Congrats on the Bonus! Here’s How Bonuses Are Taxed.
- IRS: Form W-4, Employee’s Withholding Certificate
- Bench: Payroll Tax: What It Is, How to Calculate It
- 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 (2020)
- IRS: Form 1040
- The Motley Fool: Here's How the IRS Calculates Your Income Tax
- NerdWallet: Tax Deductions Guide and 20 Popular Breaks for 2020 and 2021
- IRS. "Publication 15 (2020), (Circular E), Employer's Tax Guide." Accessed Nov. 5, 2020.
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.