You’ve earned bonuses for this year? Hooray!
But do you have to pay your taxes on them? Yes, bonuses are considered supplemental wages by the IRS so they need to be taxed as regular income is.
The good news is that it is your employer’s responsibility to work out how much to withhold from your paycheck each time you get a bonus.
Today, we are going to take a deep dive into this system.
Are Bonuses Taxed And How So?
There are many different types of bonuses – weekly, monthly, quarterly, and yearly to name a few.
You can get paid for many different reasons – a performance bonus, commission, a gift from the company, or for taking on a new role.
It does not matter what type of bonus you receive, they are all taxed in the same way.
The IRS classes bonuses as a supplemental form of income and taxes it in the same way your regular income is taxed.
It will be up to your employer to withhold the taxable amount from your bonus check, as they do with your regular paycheck.
The 2 Ways Your Employer Can Declare Your Bonuses
There are two different ways your employer can work out how much money to withhold from your bonuses.
A. 22% Method
This is the easiest method for an employer to use.
Most bonuses are taxed at a flat 22%. So, your employer will withhold 22% of all your bonuses and pay them as tax for you.
This will save them time.
The downside of this method is that if you are in a different tax bracket, then you might even end up not paying enough tax on your bonuses and end up with a surprise bill at the end of the financial year.
B. Aggregate Method
In this method, your bonuses and your paycheck are combined each month. Your employer then works out the tax to be withheld each month based on the total you are earning.
There is still a chance that you don’t pay enough tax with this method, but the chance is a lot smaller.
In fact, you are more likely to pay too much tax and end up with a refund at the end of the year.
The only real downside of this method is that it creates more work for your employer.
5 Things You Can Do To Get The Most Out Of Your Bonuses
The good news is that there are a few things you can do as an employee to make sure that you are paying the right amount in taxes.
While paying too much tax will mean that you get a refund at the end of the year, this is not helpful if you are struggling to get by on a day-to-day basis.
#1 – Put Your Money Into A Tax-Advantage Account
If you don’t have one already, make sure that you set up a tax-advantaged plan, such as a 401(k), HSA, or a traditional IRA this year.
These are the best option for most people if they are looking to reduce the impact of their tax bill on their bonuses.
Most of these accounts have a limit to how much you can put into them each year, but even if you just use them for a small percentage of the bonuses you are receiving you will save yourself money.
You can have your employer pay the bonus straight into one of these accounts and no tax will need to be withheld.
Even better, the money will be earning you more money for your future while it is sitting in one of these accounts.
#2 – Check Your W-4 Is Up To Date
The amount of money your employer will hold back from your paychecks will be based on the information on your W-4 forms.
If the information on this form is incorrect or out of date then you could end up paying completely the wrong amount of taxes.
This could lead to your paying too much or not enough and ending up with a nasty bill at the end of the year.
After each bonus payment you get, take a look at your W-4 and make any adjustments you need to. This should only take you a few minutes if you do it regularly.
#3 – Consider Deferring Your Bonuses
There are two reasons why you might want to ask your employer to defer your bonuses to the next financial year:
- You expect to earn less next year
- You think your bonus will push you into a higher tax bracket and will raise your tax bill for the whole year.
If you have problem number 2 then deferring your bonuses will prevent you from having to scramble together to pay a bigger tax bill at the end of the year.
#4 – Keep Track Of Your Tax Deductions
Most people save more money by taking the standard deduction option on their taxes.
However, if you are looking to save money, then you should make an itemized deduction and see if you can save money that way.
#5 – Double-Check Your Bonuses Are Taxable
You will want to check that the money you are receiving is actually a bonus – for example, books, flowers, tickets for games, overtime expenses, and more are nontaxable.
Make sure the line is drawn before putting money aside.
If you are receiving bonuses this year then you will have to pay taxes on them.
Bonuses are considered taxable supplementary income and will be taxed at the same rate as regular income.
It will be your employer’s responsibility to work out home much money to withhold from each of your paychecks.
You can make sure you are paying an accurate amount of tax by keeping your W-4 up to date and keeping track of how much money you have earned in total each year.
If needed you can ask your employer to defer your bonus to the next financial year to prevent you from moving up a tax bracket.