Receiving a bonus from your employer for a job well done is cause for celebration. But, you may not be so elated when you find out that your bonus could be taxed at a higher rate than your usual salary. How you will be taxed depends on how your employer treats your bonus, and your bonus could also boost you into a higher tax bracket. While your bonus tax rate won't be 40 percent, you are responsible for other taxes including Medicare, Social Security, unemployment and state or locals taxes, too.
What Are Supplemental Wages?
The IRS considers your bonus to be supplemental income, which is taxed differently than your ordinary income. Finance website Investopedia defines a bonus as, "a financial compensation that is above and beyond the normal payment expectations of its recipient." Supplemental wages can include accrued sick leave, tips and commissions as well as back pay, awards or prizes. Bonuses in the form of goods or services are taxed at their fair market value.
While all bonuses are supplemental wages, the way you're taxed depends on whether you received the bonus separate from your regular pay, or if you received it rolled into your regular paycheck.
The Aggregate Method
If you receive your bonus rolled into your regular paycheck, then your employer will use the aggregate method to determine how much tax to withhold using the information you supplied on your W-4. When you're given your bonus along with your paycheck, then your employer will tax your bonus along with your regular salary at the same time. However, it will still feel like you're being taxed more. This is because as you're paid more, the more that has to be withheld to cover your tax obligations.
The Percentage Method
The percentage method of calculating your bonus tax rate is used when you receive your bonus separate from your regular paycheck and can result in higher taxes than the aggregate method. With the percentage method, your regular salary is taxed at your marginal tax rate. But, your bonus will be taxed separately at a flat bonus tax rate, which at the time of publication is 22 percent.
If you're in the 10 or 12 percent tax brackets, then it becomes clear how you may see less of your bonus show up in your account than you were expecting.
Other Taxes on Your Bonus
In addition to the federal income taxes you have to contend with, you will also have to pay other taxes on this supplemental income. Social Security, Medicare, unemployment taxes and any state or local taxes applicable to your income must be paid as well. However, you may avoid having to pay any additional Social Security tax on your bonus if you have already exceeded the Social Security tax limit.
Another Tax Bracket
Because the U.S. tax system is structured as a progressive one, it is possible to have your bonus boost a certain percentage of your wages into a higher tax bracket. Contrary to popular belief, taxpayers are not taxed at one rate. Rather, your income is taxed at different increments ranging from 10 to 37 percent. If your marginal tax rate is 10 percent, a nice bonus could push the amount of your income that exceeds the 10 percent bracket's limit to the 12 percent tax rate.