Nothing feels better than an end of year bonus. You worked hard, you kept your chin up, and now you’re reaping the rewards. Whether that money is going towards an upcoming vacation, home renovations, or paying off debt—you’ll probably want to do some calculations before you begin spending. Unfortunately, your bonus is subject to tax. How it’s taxed is largely dependent on the size of your bonus, as well as some decisions your employer made.
Don’t let this distract from the excitement of your reward. Realizing your bonus is taxed will come as a disappointment. But realizing you spent money that wasn’t actually yours in the first place is far more disappointing. With a little bit of attention and calculations, you’ll know exactly how much money you actually have in your pocket.
How Are Bonuses Taxed?
The IRS considers your bonus a part of your income—but not a part of your regular income. Here’s what that means.
If you’re like most people, your employer withholds a portion of each of your paychecks in order to pay your taxes at the end of the year. If they withheld too much, you receive a refund. If they withheld too little, you pay the difference.
Your bonus will be handled practically the same way. While you will see your bonus included in your total income on your W-2, you’ll notice it’s categorized as supplemental income. What does this mean?
It means your employer has two options for how they’ll calculate the taxes on your bonus. Most likely, they’ll withhold the flat rate of 22% for federal income tax purposes. This is the simplest method for taxing bonuses.
Alternatively, they’ll lump your bonus into your regular paycheck. In this situation, your bonus will be taxed like the rest of your income. That percentage depends entirely on your tax bracket and additional factors.
Your employer will likely choose the method that benefits you the most. Sometimes, lumping your bonus into your paycheck could push you into a higher tax bracket. This might be a situation both you and your employer are unprepared for, in terms of withholdings. While the flat rate of 22% might be higher than the rate your standard income is taxed at, it would be the more favorable option if it means keeping you in your current bracket.
What Is The Amount of Your Bonus?
If you received a bonus of over $1,000,000 (congratulations), your employer will need to withhold slightly more. The first million will be taxed at the standard 22%, but beyond that would be subject to a much higher tax rate.
Best Tax Preparation Near You
Enjoy your bonus. You’ve worked hard to earn it. Just make sure you understand which method of taxing your employer used so you can ensure that they withheld enough. Are you looking to lower your tax liability as much as possible? Talk to a CPA today. Working with a CPA provides you with expert tax assistance, representation, and predictable tax outcomes. Contact us today!