Calculating your bonus tax rate may seems like a prudent move with bonus season right around the corner. I see this issue confuse people time and time again, with most people assuming that bonuses are taxed at a higher rate than your regular salary.
Let’s put the myth to rest immediately:
Your bonus isn’t taxed at a higher rate.
That’s right. Surprised?
Bonuses are taxed at the same ordinary income tax rate.
Part of the reason this myth persists is because bonuses and other types of supplemental income are subject to different rates of withholding.
Of course, the amount withheld from your paycheck has no relationship to the actual amount of tax paid each year, but it can be confusing to some. If your employer withholds too much money, the Internal Revenue Service will be giving you the money back next year in the form of a tax refund after you’ve filed your tax return.
The internet isn’t very helpful either, with a lot of websites mistakenly declaring the supplemental tax rate to be a 22% flat tax. Again – there is no such thing. I would link to the sites I’m talking about, but I don’t want to give them any more exposure then they already have.
What’s your income tax on bonuses?
If you’re wondering how bonuses are taxed, I’m going to explain it in this section.
But first, you need to understand that the IRS considers supplemental wages to be any income paid to an employee that aren’t part of your regular wages in a regular paycheck.
That means most bonuses are supplemental wages.
When your employer makes a supplemental wage payment to you (i.e. bonus), they have two options for how to treat your bonus.
Option 1:
If the supplemental wage is combined with regular wages and there’s no indication as to which part of the payment is regular wages and which part is supplemental, then the employer withholds as if the total was a single payment for a regular pay period.
That means if you are normally paid $5,000 a month and get a bonus in one month for $5,000, the IRS will treat you as if you’re making $120,000 a year (not ideal for you!).
Most employers don’t like this option either, so it’s not very common.
Option 2:
The vast majority of employers make it easy on themselves and separate the supplemental wages from the regular wages.
This is why you’ll often get one paycheck with your salary and a separate paycheck with your bonus.
If this is how your employer handles bonus payments, they’ve separated your “regular” wages from your “supplemental” wages.
The result?
Employers are required to withhold from your paycheck a flat rate of 22% of the bonus payment. (i.e. the withholding rate).
If you look at any recent bonus payment, it’s highly likely you’ll see that your federal withholding on your bonus payment is exactly 22%.
Just to reiterate, this has nothing to do with the actual bonus tax rate. This is only the amount that your employer is withholding and sending to the government and tax withholding is not the same as the total amount of taxes paid.
Bonuses, like regular income, are subject to medicare and social security taxes, so your bonus check should show deductions for medicare taxes in addition to the the deductions for federal income tax and state taxes (state income taxes vary by state so there is no single answer for how much will be withheld from your paycheck by the state – check with a tax professional in your area to be sure).
How to calculate your supplemental wages bonus tax rate
Calculating your actual bonus tax rate in a typical tax year isn’t that hard.
Your bonus is taxed at the same rate as all of your other income.
If you’re in the 33% tax bracket and you receive a bonus of $100,000, you will pay $33,000 in federal taxes.
The state and local taxes work the same way. Multiply the bonus amount by your marginal tax rate to understand how much you will pay.
Since your employer may withhold more or less than the actual amount you will pay, this will get sorted out when you pay your taxes.
If your employer withholds more than your marginal tax rate, you may get a refund when you file your tax return.
If your employer withholds less than your marginal tax rate, you may have to pay when you file your tax return.
A bonus tax rate would be impossible to track
If you think about it, a bonus tax rate doesn’t make any sense either. Why would the government want to tax bonuses at 22%, particularly for high income earners that are in the 39.6% tax bracket?
If you’re paying tax at 39.6%, 22% on your bonus doesn’t sound so bad. In fact, it would encourage all high income earners to insist that their employers classify as much income as “supplemental” as possible, therefore reducing their taxable income and resulting in less tax liability.
The same would be true for income earners below the 22% marginal federal tax rate. Everyone would be crying foul and demand that bonuses get included in regular wages (to be fair, people do complain but only because they misunderstand the difference between the withholding and the actual tax due).
Finally, there’s no place on Form 1040 to include bonus income. Line 7 requires all wages, salaries, tips, etc. as reported on your W-2.
Since there’s no place to put bonus income on your 1040, there’s no way for the IRS to tax your bonus at a higher rate!
I hope that puts this personal finance issue to rest. Your bonus is taxed as ordinary income, just like all of your other wages.
Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He knows that the Bogleheads forum is a great resource for tax questions and is always looking for honest advisors that provide good advice for a fair price.
The added supplemental bonus withholding always drives me crazy as I always forget what the rate is which makes it hard to estimate the payout until it occurs. You are 100% correct the tax rate doesn’t change, though its probably so hard for people to pick up because it doesn’t have a separate line.
It’s definitely confusing to people which is why I wrote this up so I could just link to it in the future. I have conversations every year with people about “how bonuses are taxed at a higher rate” which of course just isn’t true.
I work for a small law firm and just received the most amazing $25,000 bonus. Yet the take home was $13,000?. That’s not 25%.
25% just represents the federal portion of withholding. There could be many other factors that reduce your take home, such as state and local taxes, 401(k) contributions, etc. If your federal tax withholding rate was more than 25%, your firm could be treating the income as regular wages and not supplemental wages. Either way, it won’t affect the amount of taxes you pay in April of next year.
I am sorry, this still doesn’t make sense to me at all. I personally would rather that the government take all of the taxes out that they are going to take up front per the tax bracket that I am.. I had a commission check last year for $13,101.10 The break down was, Fed income:$1,031.10, SST: $812.32, Medicare tax: $189.98, NJ State income tax: $267.24, NJ SUI/SDI Tax $92.37, 401k: 524.07 NET PAY: $10,184.57. That’s not 25%. That’s 22% on everything, not to mention, I thought you said the Federal portion was supposed to be 25%? They only took about 8% federal??? Lastly, because of this and my commission checks throughout the year, separately paid from my salary, my wife and I owed a lot of unexpected money in April. My employees explanation was, In short, the commissions are keyed in as a 9 week payment. They are keyed in this way because it is considered a quarterly payment (not a weekly payment like our weekly pay). What does that mean?
It’s always painful to see so much taken out of a bonus check. But it’s nice to get my money back if there are any overages.
The payroll tax is hitting income up to $127,200 now. Gotta love Big Government!
Sam
Ugh, thanks for reminding us Sam. $127,200 is way more than the increase inflation too.
How’s not paying taxes working for Texas and Kansas? I always roll my eyes at people griping about how much they think they pay in the U.S. Americans pay nothing.
I was very confused by the withholding when I received my first bonus! I thought it was a flat tax and I remember googling and reading misleading things. You need to keyword stuff this post so that people find it 😉
I hope it will show up in the search engines. It really is awful if you Google it right now. Sites will tell you “yeah, your bonuses get taxed at 25%” – not true!
Thanks for the article. I just experienced this with my first “real” bonus and I was blown away by the 25% withheld. I’m a layman when it comes to this stuff…for the most part. So, whether it’s a withholding or a tax rate, it’s still a huge chunk of money that is going to the federal government and not my bank account. I’m one of the “bemoaners” that you mentioned and to me it’s all the same, just different terminology. Is there legislation that put this into place that could possibly be changed? Has any political party or group tried to change this? I would be interested to know the history of this supplemental wage withholding and what the justification for it was when it was introduced. Not asking you to provide all of that, just venting my curiosity. I’ll be doing some research to find out these answers. I’m not a high earner, I’m in the middle so this is definitely a much larger amount taken out/withheld, by percentage, than I’m used to on my regular pay check. Thanks again for clarifying some of the confusion with this article.
I don’t know the history, but if you find out please come back and update us. I understand your frustration over having no choice in the matter but perhaps think of it as forced savings. When you get that all back on your tax returns it’ll be a nice surprise.
My income or salary gets taxed at 29.62% as tracked by ADP iPayStatements. My bonuses get taxed at 37.8%. The program shows a graph and lists the % of income taxed, taken home and invested. I still don’t understand this even after reading the article.
Remember, we’re talking about withholding (not actual taxes). Everything is taxed the same. I’m not sure why your employer is withholding 37.8% of a bonus check. Are your bonus dollars included in your regular paycheck or in a separate check? If separate, I would think it would be 25%. Maybe worth asking HR.
It’s probably exactly because his employer is (correctly) treating bonus income like ordinary income for the actual calculations, but then separating it out from salaried income when reporting it to him on his pay stubs.
Let’s assume he has 24 pay periods a year (i.e., checks twice a month). This would work the same for bi-weekly, which would be 26 pay checks a year, or monthly, which would be 12 paychecks a year, or whatever else. But let’s just go with 24 for the sake of an example.
Each pay period, his company’s software is just looking at 2 things: the amount of ‘take home pay’ and the withholding rate he’s requested via his W4. By take home pay I mean gross taxable income, so gross pay less any pre-tax deductions like 401k contributions, healthcare costs, etc.
So in this scenario, for every pay period, the company’s payroll software/team is doing a simple calculation to determine the appropriate marginal tax rate(s) to apply: (amount of take home pay) X (24).
Why is it doing this? Basically, he is getting paid 2x monthly, but the federal government reckons taxes on how much he gets paid annually, not how much he gets paid in a single check. This is a problem because the payroll system needs to withhold the money now, but it doesn’t know what his annual total income will be. So the payroll software is attempting to figure out how much he will make annually based on the the inputs available to it, i.e., how much he is getting paid in this pay period and how many total pay periods there will be in the year. Since this pay check is 1 out of 24 he will receive in the year, it assumes that if it multiplies whatever he is getting paid in this check by the total number of checks he will get paid for the year, then it it will have his total annual income, which is what it needs to determine his tax liability on the money he earned in this pay period.
The important thing to note here is that this calculation isn’t “smart”. It’s going to (mistakenly) assume that the total take home pay for any given period is going to happen exactly the same way 23 more times in this calendar year. So when he has a pay period that is substantially higher than ‘normal’ because of a one-time or quarterly bonus, it’s going to create a ‘new normal’ to decide how much it needs to withhold for taxes. In these ‘higher’ pay periods, his total income is going to be over-withheld, and he will end up getting this amount credited back to him at the end of the year when his final annual tax burden vs total withholding is calculated (i.e., when he ‘does his taxes’ the following April).
This can be avoided, but it’s a bit of a pain. If he knows when he will be paid a bonus, he can go in and manually adjust his W4 so a lower total percentage of income will be withheld in that pay period. This post is already super long, so I won’t go into detail on this, but it’s 100% possible, 100% legal, but also a 100% a hassle and for most people not worth bothering with.
Anyway, back to this specific case. It sounds like in the case of this guy’s company, something especially misleading is going on. For employee reporting purposes on pay stubs, it is separating out the bonus and salary income as two separate buckets and giving him a separate breakdown for each. Keep in mind that this makes sense to him and the company, to look at salary and bonus income separately. But the IRS does not care, it treats all this income the same. This is helping to create the misconception that different rates of withholding are being applied to different types of income.
Basically, the payroll software has decided to ‘start’ with the salary income and ‘finish’ with the bonus income. So the salary income seems like it is being withheld at a lower tax rate, but this is only because the software has arbitrarily chosen to calculate it ‘first’, so that income has been withheld starting with the lowest tax rate possible, only graduating up to the highest marginal tax rate it is eligible for. On the other hand, the bonus income withholding is picking up at the highest marginal tax rate where the salary income left off, and possibly even jumping up into higher marginal tax rates beyond that.
Again, this is all happening because the payroll system has arbitrarily separated two types of ordinary income (salary and bonus) that the IRS treats the same. If the software operated differently, and the bonus income was treated first, he would be left with the opposite (but equally incorrect) impression that his bonus was being withheld at a far lower rate than his salaried income.
I received a bonus and the withholding was 44%!! What the heck?!
Good, clearly written post. Even motleyfool got this one wrong (at the end they kind of allude to the fact that the tax rate isn’t actually different, after an entire article explaining how it is): https://www.fool.com/retirement/2016/12/07/how-are-bonuses-taxed.aspx
My wife’s co-worker just now discussing a bonus also though it was taxed higher. I had a co-worker who thought the same and I always had a sense that come tax time it worked itself out because I recalled nothing in my W2 mentioning my actual bonus (you get at this with the 1040 bit at the end).
That Motley Fool article is horrible!! The author is clearly confused about the difference between withholding and the actual amount of taxes you pay.
@Big Law Investor: Explain to me how bonuses and wages are taxed the same. In calculating the taxes taking out of my most recent bonus, it was 25%. For wages, it was 16% every paycheck.
Kevin, maybe I can provide an explanation how I am viewing the 25% withholding. For me, it is the way the IRS wants to ensure you don’t under pay your annual taxes because of “supplemental” (additional) income potentially bumping you up into a higher tax bracket. Are they looking out for you? Maybe. Is it a way to bring in tax dollars faster? Possibly.
Come tax-time, your income (or adjusted income) will determine your tax bracket and the taxes that you have already paid, will be trued-up accordingly (tax refund/tax owed).
Just my two cents…
It’s a safe harbor for the employer. They withhold 25% because the IRS requires them to do so and the employers don’t have to worry about whether they are under-withholding.
Tax withholding is different from tax paid. Let’s say you make $1,000 per paycheck, and your income tax rate on your tax return is 25%. Theoretically your employer would withhold 25% per paycheck and you would break even when you file your return (no refund, no money owed). However, you could technically ask your employer to withhold all $1,000 and send it to the IRS (let’s ignore employment taxes for the sake of the example). When you file your tax return, you’ll still ultimately pay just 25% tax, and all of the extra tax withheld will be a refund to you.
Just to clarify, by withholding vs tax, you mean what’s withheld throughout the year vs what you actually owe at tax time? I just see it as less money in my account. My employer gives a $250 bonus any time I get a special recognition but my paycheck is only increased by $143 each time I’ve received one. That would mean they’re withholding about 43%. Is that an absurd percentage? My bonuses are included within my regular paycheck. Would I really make that difference back dollar for dollar in my tax return?
Yes, you will get the extra withholding back as a larger refund (or smaller tax bill).
I read somewhere, if you’re expecting to receive a bonus, you can submit an updated W-4 form to your employer. On it, you can select tax exempt status. Then after you receive the bonus, submit a new W-4 form with the correct amount of withholdings.
Any idea if that’s legal?
I am receiving about 5 years of back pay, which counts as supplemental income and will be taxed at a flat rate of 22%. This backpay along with my income for the current year will put me in the 35% tax bracket (i’m single) when it’s time to pay. This is going to lead me to owe tens of thousands of dollars when tax time comes. What kind of professional should I talk to help me with trying to get my AGI lowered or should I just adjust my W2 to withhold more of my regular income throughout the year? or perhaps find a single woman to sign a prenup, marry her and divorce her afterward after I file. (it looks as if that would save me $33k in fed taxes) If Income and Supplemental income are both taxed at the same rate at the end of the year, why are they withheld so differently?
After seeing an email from HR about the bonux “tax rate” I thought “huh?” — I had to look through a ton of crap on the internet that kept indicating the different rate exists but I knew this was simply not true. Thank you for the article that puts my mind to rest. Who cares what your withholding is, all that matters is the actual tax at the end of the day.
And for low income earners who complaint, fix your W4 appropriately and quit giving the IRS a free loan.
Thank you! I keep trying to tell my husband this, but he insists on believing what his general manager at work told him.
Thanks for the clear and helpful answer to my question! Trying to figure out if my bonus was getting taxed at a higher rate. While I’d like to have all of my money now I also like getting a larger tax refund.
Thanks for clarifying this point. I think people are getting confused with “Withholding” versus “Actual tax” being paid in April. It is true that the Withholding may be higher depending on how the company processes it, but at the end you pay the same amount of tax. I recently got a bonus and was worried, but when I checked my W2, Box 1 was just salary+bonus-deductions. So you are absolutely right, that the bonus actually gets taxed at the same Income Tax rate.
Bingo. That’s it. The difference is “withholding” vs “actual tax” just as you said.
@BigLawInvestor, marvelous article. Does the same logic apply to RSU Vested amounts as well? Say I made $1000 in regular wages, and $200 in vested RSUs in 2018, I thought a flat 22% tax rate is applicable to $200 and the $1000 is taxed at the brackets stuff. ?
The same thing applies to RSUs, there’s no such thing as a flat tax on RSUs either. Your company may withhold RSUs at 22% by selling a portion for you and converting to cash that it hold back for the IRS, but that doesn’t really mean anything in terms of what the IRS actually will say you personally owe at the end of the year. In reality, you’ve got to pay taxes on the value of the RSUs you’ve been granted at your highest marginal tax rate for that calendar year.
For example, let’s say you make $160k in salary in 2019, and for simplicity’s sake, let’s say that you are single, made zero 401k contributions and had no other source of income. Looking at the 2019 tax tables, at $157,501, you entered the 32% marginal tax rate. So on that last $2,499 of your salary, you have to pay a 32% tax rate. Now let’s say that you also got 1,000 shares of RSUs that vested in 2019. And let’s further say that the value of each share of each share was $50. That means the value of that RSU income at the time of vesting in 2019 was $50,000. The IRS at the end of year will treat this no differently than ordinary income. It’s just like your company paid you an extra $50k in cash.
So in this example, you’re already in the 32% marginal tax rate. And looking back at the tables, that 32% rate goes for income earned from $157,501 to $200,000. So, the first $40,000 dollars of your RSUs will be taxed at 32%, because your base salary left us at $160,000 (160,000 + 40,000 = 200,000).
Now, that leaves us with $10,000 worth of RSUs you still need to pay tax on. For income from $200,001 to $500,00, the marginal tax rate is 35%. So on that last $10k, you’ve got to pay 35% tax, not 32%.
In this case, if your company is withholding your RSUs at 22% instead of a weighted blend of 32-35%, you’re going to end up needing to make up that difference at tax time. This does not necessarily mean that you will end up ‘owing’ the government money at the next tax season, because there’s lots of other factors in play, especially the withholding rate you’ve chosen to apply to your regular salary, tax credits you may be eligible for, etc. But it does increase that likelihood that you might owe instead of getting a ‘refund’ come April 2020.
Another myth out there that I can bust for you: you do NOT have to pay taxes on RSUs twice. You pay the original value of the RSU grant as ordinary income tax (what I just laid out above) and then whenever you choose to sell the shares that you now own, you pay taxes on any profit that has accrued from the share price going up.
So for example, say you still have those 1,000 shares that you were given at a value of $50 each. If you by the time you sell the shares, they are valued at $60, you have to pay taxes on the difference in value. That would be $10 in profit per share, or a total of $10,000.
If you realize that profit within 1 year of the original grant, the IRS also treats that as ordinary income on which you’d pay your highest marginal tax rate (see the above exercise for how the mechanics of that would work). However, if you have waited more than 1 year, then the IRS treats that $10 profit as a long term capital gain, which means that you are now actually in flat tax territory!
Long term capital gains are taxed at a flat rate that varies by your total ordinary income for that year. If it’s less than $40k, you pay ZERO tax. However, in this scenario, your total income is over $200k, so for you the flat long term capital tax rate is 15%. So in this scenario your taxes owed would be $10,000 * 15%, or $1,500.
However, let’s say you sold within a year instead, making this a short term capital gain. Well, in that case it’s treated as ordinary income, and if this all happened in our scenario above during the 2019 calendar year, you’d still be in that 35% tax bucket. So, your taxes owed would be $10,000 * 35%, or $3,500.
OK, that was a lot, hope you made it all the way through, and hope that it helps 😛
All, thanks for the replies and input however I am still at a loss for understanding… My company too uses ADP software, we just received our commission check which is paid separately from our salary checks. I have the ability to see my pay statements from 2017-current. The amount of taxes withheld for federal, state (SC), medicare and Social security total to 45% on this check as opposed to 35-38% on years past dating to 2017. I went in and changed my W4 to 9 allowances weeks prior to this payout to try to reduce this but it had no affect on the take home pay, care to provide any insight as to why this is the case? something new in 2020 perhaps?