Nov 27, 2023

How Do Taxes Work With Bonuses?

It would seem obvious: A bonus is income and gets withheld and taxed just like the money in the regular paycheck. But in reality, it's more complex than that. Read through for details so no one faces unpleasant surprises at tax time.

 

Bonuses, frequently given at the end of the year, are a popular "thank you" for a job well done, and smart business owners know they can build loyalty, helping retain the most productive employees. However, both owners and employees often misunderstand how taxes work with bonuses, leading to confusion and frustration. Fortunately, with some education and preparation, the situation can work out for everyone.

In brief, bonuses are income and are subject to relevant federal and state taxes — including FICA. Businesses must enter any bonuses on their employees' Form W-2s. However, when it comes to federal income taxes, the withholding is different from the regular paycheck.

The IRS allows the following two withholding methods. If the bonus is separate from the regular paycheck, an employer will typically use the percentage method, which means the 22% rate applies to everyone. This is an easy system for the employer. However, employees who are in a higher bracket may thus find that too little was withheld and they will owe money. Those in a lower bracket may find too much withheld, leading to a refund.

The aggregate method is more complex for the employer but may lead to a more accurate withholding: The employer combines the bonus into a regular paycheck and calculates the withholding as usual, based on the employee's Form W-4. Of course, employees are sometimes careless about updating this form, which may mean too much or too little is withheld. So it's always a good idea for companies to remind employees to review their Form W-4 information annually.

Still more special rules

Those are the basics, but other special rules may apply to further complicate the situation:

  1. Extra-large bonuses. In some businesses, top employees may receive a seven-figure bonus. In this case, a higher withholding will apply.
  2. Incentive plans. These are common in the automotive industry and in rare exceptions are listed on Form 1099-MISC instead of Form W-2. No taxes are withheld, but employees still have to report this as income.
  3. Delayed bonuses. Some employees may be better off from a tax perspective by taking a bonus in the following year. The company can agree to do this, but this doesn't eliminate any tax; it just postpones it. Recipients should work with a tax professional to make sure this is a prudent strategy.
  4. Sending the bonus straight to the retirement plan. Employees who haven't reached the maximum contribution limit can put some or all of their bonus into a 401(k) plan, for example, reducing taxes and reaching a savings goal faster.
  5. Making sure a bonus really is a bonus. Although money is taxable, other items of value, although called "bonuses," may not actually be taxable. Seasonal gifts, occasional sporting or concert tickets, and various minor fringe benefits may not be subject to tax. The line can be thin, however, so be careful.

The bottom line? Both companies and employees should work with tax professionals so bonus time is a happy time for everyone.

©2023


 

MORE RECENT NEWS…


Jul 31, 2025

Lose an Employee but Gain Information

Employers conduct exit interviews with departing employees during the final days of offboarding. If done right, these interviews can be a source of valuable information to help the company improve.


Jul 30, 2025

How To Budget for Salary Increases

One of the most important ways for an employee to feel valued by their company is to receive a salary increase. This also helps with retention! Read through for ideas on deciding how much of a salary increase should be awarded to your employees.


Jul 29, 2025

Is This Your Situation: Protecting Against Employee Theft

Business owners lose about $50 million a year to employee theft and fraud, according to the U.S. Chamber of Commerce. Read through for a glimpse at some of the many ways employees could be stealing from you.


Jul 28, 2025

OBBBA: Learning the Deduction Details

The recently passed law has a lot of complex provisions, which have led to a lot of misinformation! Fortunately, the IRS has just published a guide to many of the new rules. Read through to read about them, so you can discuss them with your tax advisor.


Jul 03, 2025

What To Know About Fringe Benefits and Taxes

When you provide workers with additional benefits on top of their regular pay, some may be taxable. As the rules can get complicated, it pays to familiarize yourself with the requirements. Read through for an overview of which benefits are taxable.


Jul 02, 2025

Working 'Off the Clock': What Employers Need To Know

Disputes over unpaid work time often arise from tasks performed outside official hours — for example, answering emails, traveling between jobsites or changing into work clothes. Employers must understand when these activities count as compensable work. Read through to learn how exempt and nonexempt statuses affect wage obligations.




More News & Press can be found in our Archive.