When you earn money, you know you’re going to pay taxes. But when you pay taxes on bonuses, the rules are a little different. This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn...
There’s nothing like a bonus to make you feel better about your job. Whether it’s the year-end check that makes holiday shopping a little less stressful or just a reward for your great performance, a bonus is always a welcome windfall.
Of course, when you earn money, you almost always have to save some of it for Uncle Sam. So how are bonuses taxed, exactly?
How Bonuses Are Taxed
Here’s what the IRS says about how it determines classifications of bonuses and how taxes play a part.
First, What Qualifies as a Bonus?
According to the IRS, that bonus of yours is considered “supplemental income,” a category that also covers commissions, overtime pay, prizes, retroactive pay increases, and more.
Supplemental income is subject to a slightly more convoluted withholding pattern than your regular wages, depending on how much of a bonus you earn and the way in which your boss disperses it.
How Normal Bonuses Are Taxed
In most cases, a bonus is paid and identified separately from your regular wage by your employer — and in that case, your employer can use a couple of different methods to calculate the tax withholding.
Option 1: A flat 22% of your bonus is withheld. Pretty simple — and nice, if you earn enough money to put you in a higher income bracket overall. (Not so nice if you’re in the 10% or 12% brackets, though.)
Option 2: If your bonus is added into a regular paycheck, your employer can use the aggregate method, which is more complicated. Basically, the withholding for the total check amount is calculated as it normally would be per your income bracket and W-4 information, and then your employer subtracts the amount that would be withheld on a regular paycheck.
For instance, if you get a check for $4,000 — a $3,000 bonus on top of your normal $1,000 wages — your employer would calculate the amount you’d be taxed for $4,000 in regular wages. Say that amount was $300, and you normally see $50 of your $1,000 check withheld. In this case, your employer would subtract the $50 from the $300 to get a total withholding of $250.
How Bonuses Over $1 Million Are Taxed
OK, this might sound unrealistic for many of us, but here’s the rule:
If you earn more than $1 million in supplemental wages, the first $1 million will be taxed at the regular 22%, and then the remainder will be taxed in your regular income bracket, which in this case is 37%. Ouch. But then again, you’re earning a million-dollar bonus, so maybe you’re not that worried about it.
How Non-Cash Extras and Perks Are Taxed
You might be thinking you’re off the hook if you didn’t receive a traditional, lump-sum bonus this year, but other perks you have received might also be taxable.
These perks are called fringe benefits and include anything that adds value above your normal rate of pay: cash awards, health club memberships, vacations, tuition reimbursement, travel compensation, etc.
Basically, if you receive a benefit from your employer that provides a significant value and has a cash equivalent then it’ll be taxed. These taxable fringe benefits are taxed at their fair market value. For example, if you’re given a vacation package that has a $2,500 value, you’ll be taxed as if you had received a $2,500 bonus.
Tuition reimbursement, however, is a special case. Tuition reimbursement is tax-free up to $5,250. If your employer pays more than that, then the first $5,250 is still tax free, but anything more than that will be taxed.
Your employer should be keeping track and submitting these extra perks as taxable income, but it’s always good to keep track of them yourself as you’re ultimately the one responsible to have an accurate tax filing
Why You Could Get Some of That Money Back
Remember if your employer doesn’t specify that the extra cash is a bonus and just lumps it all in with your regular pay, it’ll be taxed at the same rate your regular paycheck would be, without any fancy mathematical acrobatics.
And although the bonus is subject to specific tax rules when it’s paid, when Tax Day comes, it’s treated just like any other kind of income. That means you could earn some of your bonus back in the form of a refund if your tax return shows too much was withheld for your total taxable income level, after accounting for deductions and credits.
No matter how it’s taxed, a bonus is basically free money you weren’t expecting. And you don’t have to worry about your bonus catapulting you into a higher tax bracket, either — because even if it does, only the money above that bracket threshold will be taxed at the higher rate.
Although it can be frustrating to see part of that check disappear into the ether, focus on the positive: the sudden cash infusion.
Jamie Cattanach and Whitney Hansen are veteran personal finance writers and The Penny Hoarder contributors.
This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.