For many employees, periodic bonuses bring both joy and confusion. Employees appreciate the extra money from their employers, especially as it often comes around the holidays, but the taxes can be confusing. Understanding how the Internal Revenue Service views bonuses and how they are taxed can help people anticipate how much of the bonus they will actually pocket and feel confident when they go to file their taxes for the year.
In the eyes of the IRS, bonuses are grouped together with vacation pay, moving pay, or severance packages as supplemental income. This basically describes all income that is paid to the employee in addition to their regular income. As such, it is taxed under a slightly different system.
If you’re fortunate to get a bonus, it will most likely be taxed under a flat rate tax system. The extra money is singled out from the rest of the income to be taxed separately. This system tends to be preferred to the alternate way to taxing bonuses because it is a flat rate that requires less work and less headache both for the employer and the employee.
Generally, the IRS will tax it at the 25% flat rate, unless you fall into the million dollar plus bonus category. If that’s the situation, then under the flat tax system the IRS will take 39.6% of a bonus amount above $1 million.
Some companies will add bonuses to the latest paycheck and tax the entire amount together. The employer would look at the sum total for this paycheck and then check the income tax rates from the IRS to determine the normal withholding amount, subtracts what was already withheld from the last paycheck, and withholds the rest from the bonus amount. For many people, this can result in more money being withheld and leave them with a higher tax burden.
It is worth noting that bonuses, in addition to being taxed for income, are taxed for Social Security, Medicare, as well as other standard local and federal taxes. This will certainly result in a bit more than the standard flat rate being withheld.
When people receive bonuses throughout the year, sometimes taxes can seem confusing. Since there are different ways of determining the taxes on bonuses, it can be even more unclear. Understanding the different methods and how the IRS views bonuses can help employees begin to make sense of the numbers they see on their pay stub.