What are the Taxes on a Bonus?

Taxes are due April 17 and bonus season is just around the corner. Recently, we’ve received a lot of questions about bonus taxes and wanted to give a clear explanation to help you plan ahead as you begin to prepare your taxes. Today question for YoBucko is “what are the taxes on a bonus?”

Bonus Tax Basics

The money you earn from your paycheck is taxed at the ordinary income tax rate which is based on your income tax bracket. Bonuses, on the other hand, are considered “supplemental wages.” Supplemental wages are compensation paid in addition to an employee’s regular wages. They include income such as bonuses, commissions, prizes, awards, back pay, overtime pay, payments for accumulated sick leave, and payments for moving expenses. To estimate the taxes on your bonus, try our bonus tax calculator.

Bonuses are taxed just like your regular income from the IRS’s perspective. What is different though, is how your employer withholds taxes for your bonus. Employers have three options for withholding taxes from your bonus check:

  • Option 1 – The employer may withhold a flat 25% for federal income taxes from the bonus payment. If you earn a bonus over $1 million, they can withhold 35% for the amount over $1 million. I hope you have this problem.
  • Option #2 – The employer may add the bonus payment to the most recent regular income payment, determine the standard withholding for the sum of the payments based on your marginal tax rate, subtract the money already withheld from your paycheck, and withhold the rest from your bonus.
  • Option #3 – The employer may base withholding on the sum of the bonus and regular pay using the standard withholding tables and not differentiate between the two types of income.

Regardless of your employers method of calculating your bonus, your income from the IRS’s perspective is all the same when you file your taxes. The difference is how your employer decides to withhold your bonus compensation.

What are Marginal Tax Rates?

If your employer bases their withholding using standard tax tables your withholding will be based on your marginal tax rate. What is a marginal tax rate? It is the income tax bracket you fall into for the last dollar you earn. For example, if you earn $100,000 and you are single, you marginal tax rate is 28%. Your effective tax rate (i.e. the taxes you actually pay) is lower though. Why? Because your income is taxed in increments, or tiers. As you can see in our 2011 income tax brackets, the first $8,500 you earn is taxed at 10%, but if you earn $100,000, your federal income tax calculation is $17,025 + 28% ($14,600) = $21,113. So your effective tax rate is 21.1%. Where did we get $14,600? That is the amount you earned above $83,600 that is taxed at your marginal tax rate.

The Bottom Line

When you get your bonus check this year, it may look a little lean. Don’t fret. If it appears low, it may be based on your employer’s method of withholding bonus taxes. If they withheld too much, then you will get a refund from the IRS when you file your taxes this year.

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