What Is a Bonus?
A bonus is additional compensation an employee receives from their employer beyond their regular wages or salary. Companies award bonuses to reward exceptional performance, share profits, or mark special occasions like holidays. This extra pay can come as cash, stock options, or other benefits.
Types of Bonuses
- Discretionary Bonuses: These are given at the employer’s discretion without any prior obligation. For example, a holiday bonus or a surprise reward.
- Non-Discretionary Bonuses: These bonuses are pre-determined and linked to specific criteria, such as meeting sales targets or company performance.
How Are Bonuses Taxed?
According to the IRS, bonuses fall under “supplemental wages,” which means they are subject to federal income tax withholding, Social Security, and Medicare taxes. Employers typically withhold taxes in one of the following ways:
- Flat withholding rate: A common method for bonuses under $1 million is a flat 22% federal income tax withholding.
- Aggregate method: The employer adds the bonus to the employee’s most recent regular paycheck and withholds tax based on the employee’s overall tax bracket.
In all cases, the bonus amount is subject to Social Security and Medicare taxes. The actual tax you owe depends on your total annual income when you file your tax return, so you may receive a refund or owe additional taxes.
State Taxes on Bonuses
Most states tax bonuses as regular income, but withholding rates and rules vary. It’s important to check your state’s guidelines or consult with HR.
Practical Examples
- Receiving a $1,000 Bonus: Your employer withholds 22% ($220) for federal taxes upfront.
- Year-end tax bracket effect: If the bonus pushes your income into a higher tax bracket, you may owe more taxes when you file your return.
- Stock Bonuses: Timings for taxation might differ—usually, you pay taxes when stocks vest or when you sell them, possibly triggering capital gains tax.
Who Typically Gets Bonuses?
Bonuses vary widely by job type and industry:
- Sales roles often receive commission-based bonuses.
- Executives may receive performance-based bonuses tied to company success.
- Many companies award holiday or profit-sharing bonuses across the workforce.
Tips for Managing Your Bonus
- Budget for taxes: Recognize that a significant portion of your bonus will go to taxes, so avoid spending it all immediately.
- Save or invest: Use your bonus to boost savings, pay down debt, or contribute to retirement accounts.
- Check your withholding: Adjust your W-4 with your employer if you want more accurate tax withholding on bonuses. Learn more about Tax Withholding.
Common Misconceptions
- Bonuses aren’t “extra” tax-free money; they are fully taxable.
- Withholding on bonuses is a prepayment, which might not match your final tax liability.
- Not all bonuses are taxed identically—stock bonuses and other forms have distinct rules.
Summary of Bonus Tax Withholding
| Bonus Type | IRS Tax Treatment | Typical Withholding Rate | Notes |
|---|---|---|---|
| Discretionary Bonus | Taxable as supplemental wages | 22% flat withholding | Applies to most cash bonuses |
| Non-Discretionary Bonus | Taxed with regular wages | Based on marginal tax rate | Added to paycheck and taxed normally |
| Stock Bonuses | Taxed upon vesting/sale | Varies | May trigger capital gains taxes |
For detailed IRS guidelines on supplemental wages and bonus taxation, refer to IRS Topic No. 418. Managing bonus taxes effectively can help you maximize the value of your extra income.
Further Reading on FinHelp.io
External Resource
- IRS official page on Supplemental Wages