Julia will receive a $1.5 million bonus this year. The first million dollars will be taxed at 22% and the remaining $500,000 will be taxed at 37%, resulting in a withholding tax of $405,000. One way to recognize employees for a job well done is to reward them with a bonus. But while bonuses are great for appreciating employees, they have one twist: their own tax rules. Bonuses are taxed differently than regular salaries, so it`s important to understand the correct tax calculations to make sure you`re withholding the right amounts. Therefore, your federal premium tax is not $220 as in the previous example. Here`s how to calculate it: The exception to this rule is if your bonus qualifies as an employee performance bonus. You may be able to avoid paying federal income taxes under the following conditions: If an employer uses the percentage method (also known as the fixed rate method), the IRS requires them to withhold a flat rate of 22% of your bonus to cover taxes.1 And don`t forget about Social Security and Medicare taxes. That`s another 7.65%.
Hey, you worked hard for that money! So how do you avoid giving 32% of that to Uncle Sam? The key is to reduce your taxable income. If you`re debt-free and have an emergency fund with 3-6 months of expenses, a great way to reduce your taxable income is to put your bonus money in your 401(k). Contributions to a traditional 401(k) are tax deductible, meaning they reduce your taxable income. The annual 401(k) contribution limit is $20,500.2 Now that you know the types of bonus taxes you need to withhold, you need to be clear about how to do the correct calculations. Finally, as mentioned earlier, you calculate premium withholding differently if you pay bonuses to your employees in the form of separate paycheques rather than supplements to regular paycheques. In the first case, you use the percentage method, and in the second case, you use the aggregated method. The aggregate method is used when your employer spends your premium with your regular salary and uses the total amount to calculate the amount of withholding tax. For example, if you normally withhold 35% of your salary for income tax, the amount of your premium deduction is also 35%. If you`re in a lower tax bracket, the aggregate method means you`ll get more of your bonus in your take-home pay. If you are in a higher tax bracket, you will receive less of your bonus in your take-home pay. Let`s say your adjusted gross income is exactly $165,050, which is $5,000 below the limit between the 24% and 32% tax rate. You exceeded your sales goals for the year and your boss gave you a $15,000 bonus.
When it`s time to file your tax return, you pay 24% tax on $5,000 of your premium and 32% on the remaining $10,000 of your premium. Fiasco. That`s a big part of the change. If this is the plan for you and your bonus is large enough to put you in a different tax bracket, you can also ask if your company will defer your bonus payment until the new year. Your bonus may also be subject to state taxes, although the withholding tax rate varies from state to state. Therefore, the employee`s actual annual salary for the month is not the usual annual salary of $6,500 x 12 = $78,000. Instead, it`s $7,500 x 12 = $90,000. While the employee`s standard income of $78,000 is equivalent to a federal tax rate of 22% (assuming the employee is a single tax filer who is not the head of household), his or her effective annual salary of $90,000 falls within a higher federal tax bracket with the premium, for which taxes are levied at a rate of 24%. This is the rate at which you withhold taxes on the bonus you paid. Since bonuses can occur at any time of the year, they are added to your salary on a case-by-case basis. And it can inflate your income, push you into a new tax bracket, and increase your tax liability. Another option is to ask your employer to give you all or part of your bonus next year.
Yes, you`ll have to wait to get your money, but the tax savings might be worth it. But you`ll only save on your taxes if you plan to earn less next year. So if you`ve had a banner sales year that you don`t expect to repeat, or if your spouse quits his job to stay home with the kids, ask your employer if they can delay your premium. In the aggregate method, your employer adds your bonus to your regular paycheck and then withholds taxes at your regular rate based on the information you provided on your W-4. If you work for a large company, you can see how complicated it can be for your payroll department to withhold a flat rate of 22%. Note: If your additional salary for a year is more than $1 million, your employer must apply the flat rate method and charge your premium deductions (over $1 million) at 37%. Now, let`s say Jill had a really good year. No, really, really good.
And you decide to pay him a bonus of $1,500,000. The first million is subject to the same 22% tax, bringing the after-tax withholding tax to $780,000. The next half million will be hit with a 37% tax that will reduce it to $405,000. This means that their bonus check must be written for $1,185,000. Another very good payment. It may seem like IRS tax bonuses are levied at a higher rate than your normal tax rate, but the 22% is just your withholding tax, not the actual amount of tax you owe when you file your taxes. Keep in mind that bonuses, just like salaries, are considered taxable income. Note that the aggregate method required much more work for a $4 increase in federal premium tax compared to the percentage method. Because the aggregate method can result in higher premium withholding tax and is more cumbersome to calculate, many employers prefer the percentage method.
I know I`m not the only one troubled by the missing bonus case, so I reached out to Lisa Greene-Lewis, TurboTax accountant, to find out why year-end bonuses seem to be taxed at such a high rate. The 22% flat withholding tax applies to all bonuses you receive up to $1 million, regardless of which tax bracket you`re in. So if you`re in a lower tax bracket, you`ll likely get a refund of those withholdings when you file your taxes. If you`re in a higher tax bracket — say, the 24% or 32% — you`ll probably have to write a check to Uncle Sam at tax time. Key Finding: There are three types of bonus taxes: federal bonus taxes, federal FICA taxes, and state (and sometimes local) bonus taxes. Need more help? Our flat-rate bonus calculator can help you find the right amount of federal and state taxes. Simply enter the gross amount of your employees` bonus below and we`ll get the job done. If you`ve ever gotten a bonus, you`ve been there, haven`t you? After taxes, that $1,000 drops to $780. In the aggregate method, the withholding tax on your premium is calculated at your regular tax rate. The withholding tax rate depends on your tax class. When payroll taxes plus premiums are calculated together in this way, your initial withholding tax is often higher.
Don`t wander around the 2023 tax season wondering what you owe Uncle Sam. For simple returns, start by knowing your federal tax bracket and tax rate. Here`s how. Employers have the option of withholding tax on premiums in two different ways: the percentage method and the aggregate method. Ugh, complicated accounting jargon. No thank you. But stay with us – it`s really a lot easier than it sounds. Key finding: Employee bonuses are taxable, but deduction calculations are different from those used for standard wages. For example, let`s say your business is based in a Colorado city with no local premium tax and you pay an employee a $1,000 bonus delivered by check or direct deposit separate from an employee`s regular payment. In this case, you calculate the federal bonus tax using the percentage method. Therefore, the bonus you pay your employee is ultimately not $1,000, but $1,000 minus $342.80, which is equivalent to $657.20.
