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Maximizing Your Bonus: Understanding How Bonuses are Taxed

Maximizing Your Bonus: Understanding How Bonuses are Taxed

February 06, 2023

Have you received a bonus from your employer recently? Bonuses can affect your tax burden in various ways. Therefore, it's crucial to understand how they are taxed to plan accordingly. 

Bonuses Taxed High? Why? 

When it comes to bonuses, the Internal Revenue Service (IRS) regards them as supplemental wages. This means that bonuses are subject to higher withholding rates than regular wages. 

Typically, the employer will withhold 22% of your bonus, if less than $1 million, for federal income taxes. This percentage is higher than the rate used to tax regular wages. 

The Bonus Tax Rate 

The IRS allows employers to use different withholding rates depending on the bonus earned during a calendar year. If you receive more than $1 million in supplemental wages annually, the withholding rate increases to 37%. 

Any amount below $1 million is subject to the 22% flat withholding rate. To ensure that you do not owe taxes on your bonus, adjust your W-4 form accordingly. 

How Tax Withholding Works 

Tax withholding is the amount of money that employers deduct from employee wages. This money is sent to the relevant tax authority, such as the IRS, for taxes due on income received during a given period. 

In most cases, employers use payroll deductions to pay various federal and state taxes throughout the year. When you receive a bonus, the employer may withhold extra money from the bonus payment. This means that you will get less than the full amount of your bonus because of taxes due on it. 

Paying Taxes Avoidable? 

Although paying taxes on your bonus may seem unavoidable, there are a few ways to reduce the amount you pay. One way is to use the bonus to reduce your annual taxable income. This can be done by making charitable donations or retirement contributions. 

Another way to manage taxes due on bonuses is to adjust your withholding rate. This can be done by completing a new W-4 form with your employer and having them withhold taxes at a lower rate. 

Negotiating for other perks instead of a monetary bonus is also a way to reduce your tax burden. These perks may include vacation time or additional healthcare and tuition reimbursement benefits. 

What are Supplemental Wages? 

Supplemental wages are payments made by employers to their employees in addition to regular wages. This includes bonuses, commissions, severance pay, overtime, and other payments. 

The IRS considers supplemental wages taxable income and uses a flat withholding rate of 22% to calculate the amount you owe in taxes. Depending on your total earnings, this rate may increase to 37%. 

Your Tax Burden 

Bonuses can significantly increase your tax burden if you're unprepared for them. To reduce the amount of taxes you pay on bonuses, consider taking advantage of any tax deductions available. 

Don't forget to review your withholding rate and adjust it accordingly. Understanding how bonuses are taxed will help you make the most of your income and avoid unpleasant surprises come tax season. 

Making the right decisions when it comes to bonuses can help you keep your finances in check and save money in the long run. As always, consult with a professional tax advisor if you have any questions or need assistance.