Employers often give employees extra money during Christmas or other significant times of the year as a bonus. While employees may appreciate the gesture, some worry that bonuses will force them to pay more taxes come April 15. Employers must withhold payroll taxes from bonuses just as they do from regular paychecks; thus, taxpayers may receive a refund even if they receive a bonus.
Flat Rate Method
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While bonuses are subject to income tax, they don't get added to your taxable income and charged at your marginal tax rate. Instead, your employer will tax all bonuses using a flat tax rate.
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In 2021, the tax rate is 22 percent of any bonus of less than $1 million. If the bonus is more than $1 million, employers must deduct taxes of 37 percent using this method. This means that for very large bonuses, you'll have 22 percent withheld on the first million, and then 37 percent withheld on the rest.
Therefore, if you receive a bonus of $400, your employer must withhold taxes of $88 from your bonus and forward those taxes to the federal government.
Consider also: Do I Have to Pay Taxes on My Bonus?
Aggregate Taxes on Bonus Payments
If your employer adds your bonus to your regular paycheck rather than giving you a separate bonus check, she must use the aggregate method. That is, instead of withholding payroll taxes from your bonus check based on the current flat rate, she withholds taxes on the entire amount of your check based on the payroll taxes for the entire amount.
For example, if your employer normally deducts 35 percent of your salary for income taxes, the amount of withholding on your bonus would also be 35 percent. So, if you have a large bonus, you will pay hefty payroll taxes on it if your employer uses this method.
Bonus Reporting for Income Taxes
Your employer adds any bonuses he gives you to your wages for the year and reports your total wages on your W-2. Thus, you report your bonuses as well as your wages when you file your income taxes. If your employer withheld more payroll taxes from your bonuses and regular income than you owe, you will receive a refund; otherwise, you will have to pay income taxes on your wages, including your bonuses.
Consider also: W-2 Forms: What It Is, Who Gets One & How It Works
Shifting Your Tax Bracket
Some employees worry that they will pay more income taxes altogether if they receive a bonus because the bonus will push their income into a higher tax bracket. However, this fear is not justified because the IRS does not distinguish between bonus pay and regular pay. If you overpaid taxes during the year, you will get a refund regardless of whether your bonus makes it appear that you earned a far larger amount of income throughout the year than you would have earned without the bonus.
Also, while you must pay taxes on your bonus, it may be possible to reduce the amount of tax you owe by placing the funds in your 401(k) or IRA to get a tax break.