There seems to be two different ways of looking at bonuses from an employer. People either seem to be really excited about the extra money and thinking about what to spend it on, or worried that the extra cash will bump them into a higher tax bracket and won't benefit them at all. Those that are excited about the extra cash are often surprised to learn how much of their bonus was taxed. And those worried about a higher tax bracket, are probably going to find that there is no difference at all. The truth of the matter is, getting a bonus from your employer is supplemental income and no matter how you look at it, and it will be taxed. Now you just need to determine how you are going to pay it.
How to Determine the Tax Method
There are a couple of ways an employer can tax a bonus check, either the flat rate method or the aggregate method. It's really an employers preference to which method they choose.
Option 1 – Flat Rate: Many employers choose this method for taxing bonus money because it is easy. With the flat rate method, a straight 25% is taxed on the bonus payment. If the bonus is over one million dollars, then the employer is allowed to charge 35% on any amounts over one million. The typical employee probably doesn't have to worry about this.
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Option 2 – Aggregate Method: Using the aggregate method, employers pay the bonus with the regular pay check. The total of the bonus amount and regular pay are added together, and the deductions are based on the tax tables from that total. The normal deductions including federal taxes, social security, insurance contributions and the like are subtracted out of the regular pay check and then the employee takes the difference and subtracts that amount as well. Most employers choose this method as payroll systems can better handle the calculations involved in this method.
Which is Better to Calculate
The reality is it doesn't really make a difference in which method of taxing bonuses your employer chooses to use. It's a personal or payroll system preference on the part of your employer. The amount that you see taken out of your bonus check isn't going to be that different regardless of the tax method chosen.
IRS Tax Reporting
At the end of the year, the IRS looks at all of your income the same way. So if it's regular wages or bonus money, it all get's reported on a W-2 in the same manner, as income. While your employer may have held more in taxes from your bonus then what you are used to in your regular pay, it generally evens out. The IRS determines how much tax you paid and your income for reporting purposes is adjusted accordingly. When you are completing your taxes, you are either going to find that you underpaid and owe money, or overpaid and are due a refund.
This information is not inteded to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.