It depends on how your employer pays you.
Fidelity Smart Money
Key takeaways
- The federal bonus tax rate is typically 22%.
- However, employers could instead combine a bonus with your regular wages as though it’s one of your usual paychecks—with your usual tax amount withheld.
- There are ways to reduce the tax impact of your bonus.
Your boss just delivered the great news: You earned a bonus this year. Before you start making plans to spend it, it’s important to understand how that income will get taxed. Yes, your bonus money is taxable—typically at a flat rate of 22%—and it’s up to you to make sure the appropriate amount gets paid.
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What is a bonus?
Some employers reward their employees by offering bonuses—extra money an employee receives on top of their salary. Some bonuses are included in the total compensation package when you start a new job. Other kinds of bonuses are given for referring new employees to the company, or as an incentive for highly valued employees to stay (aka retention bonuses). Another common bonus type: one given for a job well done (and a profitable year for the company), often at the end of the year.
The IRS has another name for bonuses: supplemental wages, which are payments outside the scope of an employee’s regular wages. Other examples of supplemental wages include commissions, severance pay, cash awards, and overtime pay and tips.
How are bonuses taxed?
It’s a good idea to consult a tax pro about your specific situation, but in general, your employer will withhold taxes on your bonus payment, just as they withhold taxes on your regular paychecks. Your employer can choose from 2 options when calculating your federal bonus tax rate.
- The percentage method. If your employer chooses this option, they will identify your bonus payment as separate income from your regular wages and automatically withhold 22% for taxes. One exception: For people with bonus payments that total over $1 million in a calendar year, the first $1 million is taxed at 22%, and any funds over that have 37% withheld. An employer must use this method if you receive more than $1 million in supplemental income for the calendar year.
- The aggregate method. Employers that issue bonus payments along with regular wages in one paycheck (and don’t specify the amount of each when reporting to the federal government) can withhold taxes on the entire payment as though it’s a single paycheck in a regular payroll period. This method might be used, for example, in commission-based jobs where supplemental income is awarded throughout the year.
When you see your bonus check, you might be surprised by how much lower the number is than the one your boss told you. That's because many companies withhold enough to prevent you from accidentally owing more than you expect come Tax Day. In the short term, you'll see less of your bonus, but luckily, this means you could be due for a refund equal to the extra amount they withheld.
In addition to income tax, bonus payments are subject to Social Security, Medicare, and FUTA (or federal unemployment taxes). Depending on where you live and work, your bonus check might also require state and/or local taxes to be deducted as well. If you aren’t sure whether you’re on the hook for those payments, consider talking to a tax professional in your area or your employer.,
Are all bonuses taxable?
If you receive cash or a cash equivalent (such as a gift card) as a bonus, it’s taxable. The IRS considers some offerings, known as “de minimis fringe benefits,” insignificant enough to escape taxation, however. These include:
- Occasional tickets for events
- Occasional snacks
- Holiday gifts
- Occasional meal money and transportation money for working overtime
- Flowers and other items given for special occasions
How to help reduce the tax impact on your bonus
While the onus is on your employer to withhold the right amount of tax money from your bonus check, there are tactics to help reduce the impact a bonus has on your tax situation.
Edit your W-4 as needed
Check how your bonus affects your tax bracket. Your bonus can push you up into a higher tax bracket, and your tax liability might increase. As a result, the W-4 options you chose at the beginning of the year might no longer set the proper withholding amount from your earnings to prevent a bill come tax time.
If you expect a bonus, consult the IRS tax withholding estimator tool to help decide if your W-4 needs an adjustment.
Spend your bonus wisely
Using supplemental income to fund a 401(k), an IRA, or an HSA is a strategy to potentially address your tax liability because qualified contributions can reduce your taxable income. When your bonus check hits, consider using the extra funds for these accounts (if you haven’t already hit your max contributions).
Keep in mind, though, that 401(k) contributions are made through payroll deferrals and must be made by the end of the year.
Ask for a deferred payment
If you think a bonus payment might tip the upper part of your income into a higher tax bracket, you could speak to your employer and request a deferred payment until the following year. This strategy might be particularly useful for employees who know they will earn much less the next year, say, because you’re retiring, taking unpaid leave, or going part-time. Your employer might say no, and you’ll have to figure out how to pay the taxes for this year, but it could be worth the ask.
