For a lot of people, getting bonuses at work is a blessing that also comes mixed with confusion. Anyone will agree that getting extra money from your employer is a welcome occurrence. However, the taxes on bonuses can be confusing, especially since the bonus tax rate is different than the tax rate for regular wages. Understanding how the Internal Revenue Service (IRS) taxes bonuses can help relieve some of the confusion and give taxpayers the tools they need to determine what their bonus will be after taxes.
How The IRS Views Bonuses
In the eyes of the IRS, bonuses are considered “supplemental income.” Bonus income is grouped together with vacation pay, moving pay, severance packages, and payouts for accumulated sick leave, among others. Basically, supplemental income describes all income paid to an employee in addition to their regular income. As such, supplemental income is taxed using a different method than regular income.
Flat Rate Taxes
Most bonuses are likely to be taxed using the flat rate method. Using the flat rate is often the most straightforward way for an employer to tax bonuses. The bonus is singled out from the rest of the income and taxed separately. Using the flat rate method, bonuses under $1 million are taxed at 25%. Bonuses over $1 million are taxed at 39.6%.
Aside from flat rate taxing, aggregate taxing is another option for employers to use. In this case, a company will add bonuses to the latest paycheck and tax the entire amount together. The employer looks at the sum total for this paycheck, checks 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, the aggregate tax method can result in a higher withholding, leaving the employee with a larger tax burden.
It’s important to note that bonuses are taxed for Social Security, Medicare, and other local and federal taxes, just like regular income. These taxes are withheld from the bonus, too, reducing the amount the employee gets to take home even further.
So, how are bonuses taxed? It all depends on your employer. But understanding the different bonus tax rates and how the IRS views bonuses can help employees begin to make sense of the numbers they see on their pay stub. Being educated on how the IRS taxes supplemental income also helps prevent employees from being unpleasantly surprised when they receive the after-tax amount of their well-earned bonus.
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