Have you ever been looking forward to a big bonus at work, only to be disappointed when it finally arrives and you see how much has been withheld in taxes?
There are two ways your employer can calculate your withholding on your bonus: the percentage method or the aggregate method. The percentage method withholds a flat 22%; this could be higher, lower, or equal to your regular tax rate, depending on your income.
The aggregate method treats your bonus just as it does a regular paycheck, however, this larger check may put you in a different tax bracket so a higher tax rate may be applied, but only for this one paycheck.
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How Are Bonuses Taxed?
The IRS defines your bonus earnings as “supplemental income,” as this income stream is in addition to your base pay.
Some of the other types of supplemental income include:
- Commissions
- Overtime and tips (if paid separately from your regular pay)
- Sick leave
- Vacation pay
- Severance pay
- Back pay
- Awards and prizes
There are two different ways your employer may withhold taxes from your bonus.
Percentage Method
The percentage method is the easiest and most common way to pay taxes on a bonus.
Your employer can follow these steps to calculate your withholding amount:
Regardless of your ordinary tax bracket, the IRS instructs your employer to withhold 22% federal income taxes from any bonus amount under $1 million. The 22% withholding level remains in effect through 2025, when it returns to the usual 25%. State income taxes and FICA taxes (Social Security and Medicare) are also withheld.
Your total federal tax percentages are as follows:
- Federal income tax: 22%
- Social Security: 6.2%
- Medicare: 1.45%
That’s 29.65% in federal taxes plus your state tax rate. Check with your state tax agency to estimate your state-level withholdings. If you’re in a lower tax bracket, you may be able to get a tax refund when you file your taxes at the end of the year.
Your FICA tax withholding may be different if you’re a high-income earner. For example, you pay an additional 0.9% Medicare tax if your annual income is at least $200,000. Also, you won’t pay Social Security taxes on income above the annual base limit. In 2024, the limit is $168,600.
See the federal income tax brackets to estimate your tax liability for this year.
Percentage Method Example
So, assuming you receive a $1,000 bonus, you will pay $220 in federal income tax initially. This formula is simply Bonus amount x .22= federal withholding. As your bonus is subject to FICA taxes, anticipate the total federal tax bill to be $296.50 and extra for state taxes.
Aggregate Method
The aggregate method is the other way to tax your bonus, and this is the default treatment when your employer lumps your bonus into your recurring paycheck. Your bonus is treated as if this new amount is your regular paycheck and thus taxed accordingly.
For example, instead of receiving your usual pay of $4,000, it might be $5,000 if you get a $1,000 bonus. Admittedly, this tax treatment is more complex in estimating your taxes. Your employer can follow these steps to calculate your withholding amount:
Aggregate Method Example
Sam is typically paid $1,000 every week. From this, the computer knows that they earn $52,000 per year. It can then figure that someone earning $52,000 would pay approximately $8,000 per year in taxes (this is a very rough estimate of only federal income taxes). Therefore, $154 needs to be withheld per week to meet that tax liability (8,000/52).
The payroll software does this calculation on a paycheck-by-paycheck basis. It doesn’t look back and see how much has been earned or withheld year to date. If the company enters the bonus information into the payroll software as regular salary, then that is how the software will treat it.
Next week Same receives a $1,000 bonus, making their paycheck $2,000. The computer then does the above calculation based on a $2,000 per week salary.
It doesn’t realize that the bonus means they are earning $53,000 a year. Instead, it thinks Sam earns $104,000 per year. And someone who earns $104,000 would owe roughly $23,000 in annual taxes. Therefore, the computer thinks it should withhold $442 from this paycheck (23,000/52).
It would be reasonable of Sam to have expected $308 dollars of withholding (double the paycheck, therefore double the taxes) so they are probably surprised to see the extra $134 missing from their check.
Remember that any over-withholding will be returned when Sam files their tax return. Either that or Sam will owe if not enough was withheld.
Learn more: IRS Publication 15-T covers the nitty-gritty about supplemental income taxes.
Taxes on Bonuses Larger than $1 Million
If you’re fortunate enough to be receiving bonus payments exceeding $1 million, the tax rules change on the amount larger than seven figures. Under the percentage method, your bonus is either subject to the 22% or 37% federal rate:
- Up to $1 million: 22%
- Above $1 million: 37%
So, if your total bonus amount is $1.5 million, your first million is subject to 22% taxes, and the remaining $500,000 has a 37% tax withholding.
Eliminating Taxes on Your Bonus
You must pay income tax on your bonus, but here are some ways you can potentially reduce the tax liability to keep more of your check. It’s worth asking your employer if it’s possible to use one of these strategies.
Learn more: Do I need to file a tax return?
Contribute to Tax-Advantaged Accounts
If you can put your bonus directly into your traditional 401(k), HSA, or FSA instead, you’ll avoid paying taxes on your bonus altogether.
If you can’t put it directly from your paycheck into a tax-advantaged account with your employer, you can put it into a traditional IRA. You’ll still pay taxes initially, but they will be returned to you when you file your tax return.
Your bonus can make reaching your annual contribution limits for these various savings and investment accounts easier.
Donate to Charity
If you donate your bonus to charity, you can potentially deduct the full amount from your income and, therefore, get back the taxes that were withheld.
You’ll need to itemize to be able to deduct charitable donations. However, if you already itemize, then this is a viable way to not pay taxes on your bonus. If you can file an itemized return, it’s possible to deduct your charitable donations and other qualifying tax deductions like paid mortgage interest, state and local property taxes, and medical bills.
Learn More: How to Get a Bigger Tax Refund
FAQs
Bonus payments are classified as supplemental income, which is any money you earn outside of your regular wages. Your employer may apply the 22% federal tax rate to your bonus income below $1 million. This rate can differ from your regular tax rate, which considers your W-4 details.
Your employer reports your bonus income on your year-end W-2 tax form, which is part of your gross income for tax purposes.
The tax software will calculate your estimated tax liability based on your salary and the information on your W-4. If you apply for financing, the lender may request that you separate your regular pay from any bonuses or overtime you earn to establish your base annual salary accurately.
Your bonus income reports in Box 1 (Wages, tips, other compensation) of your end-of-year W-2 tax form. This box also includes your regular pay and any additional payments you receive through your employer. Your bonus tax withholdings also populate in the same withheld tax boxes as your regular income.
If your employer withholds too much, you will get back anything you overpaid when you file your tax return. However, it’s difficult to estimate how much you may get back until you file your taxes, as you may be eligible for several tax deductions and credits.
Most employers use the percentage method, which taxes your bonus at a flat rate. As a result, the federal withholding is 22% on annual bonuses up to $1 million.
Social Security, Medicare, and state income taxes also apply. So, at least 30% of your bonus goes to taxes, but you might get some of it back as a tax refund.
Summary
Your bonus can be an excellent way to get extra cash to help save for one of your financial goals or pay off debt. However, expect at least 30% of your windfall to be withheld for taxes. It’s probably best to wait until you see your paycheck before you start making plans as to what you’ll do with your bonus.
