Similar to salaries, employee bonuses are subject to taxes—specifically, a bonus tax rate, which is typically a flat rate of 22%. This can change depending on the amount of the bonus and the method used to calculate the applicable bonus taxes. Generally, all types of bonuses need to be taxed, but reducing the tax income is one way to help minimize the tax burden. Read on to learn how this can be done, including the different ways to compute the tax amount on bonuses.
Bonus Tax Definition
Bonus taxes are taxes imposed on additional compensation that employees receive on top of their regular salaries. These payouts are also considered by the Internal Revenue Service (IRS) as taxable supplemental wages. Here are a few examples:
- Bonuses
- Commissions
- Paid incentives
- Accumulated sick leave pay
- Monetary awards or prizes
- Retroactive pay increases
- Back pay
- Severance pay
The way that taxes on bonuses are processed is similar to how taxes are levied on worker salaries. Both are withheld from employee paychecks and remitted to the IRS by employers. The applicable amounts are also reported to the IRS via Forms W-2 and W-4 by employers and employees respectively.
Bonus Tax Calculation Methods
For employees, knowing how bonuses are taxed will help them understand why the actual amount they receive is lower than expected. For employers, learning the tax calculation methods for bonuses will help ensure that payroll compliances are followed.
The IRS offers two ways for computing the bonus taxes: the percentage and aggregate methods. There’s also a special tax rate for employees who receive a total bonus amount of more than $1 million in a calendar year.
1. Percentage Method
This is the easiest way to compute the bonus pay tax rate. It requires withholding a flat rate of 22% from the employee’s bonus amount. However, this only applies if the total annual bonus is less than or equal to $1 million. If the amount exceeds this threshold, every dollar over that gets taxed 37%.
The percentage method is typically used when the bonus is processed as a separate payout. However, if the bonus payment is included in a regular pay run, only the flat withholding rate of 22% will apply to the bonus amount while the usual income tax rate will be used for the regular wage.
Note that while most bonuses follow the flat 22% rate, sales commissions that are paid out separately from payroll are taxed at 25%. If it is included in the regular pay run, then the aggregate method can be used.
| Scenario | Computation | Bonus Tax Amount |
|---|---|---|
| Sally receives a $2,500 bonus | $2,500 X 0.22 = $550 | $550 is withheld for taxes |
| Sally receives a total bonus of $1.25 million for one calendar year | $1,000,000 X 0.22 = $220,000 $250,000 X 0.37 = $92,500 | A total of $312,500 is withheld for taxes ($220,000 from the $1 million and $92,500 from the remaining bonus amount) |
| Sally is paid a monthly salary, files as Head of Household, and is subject to Standard Withholding. For January, she receives a monthly earning of $5,000 and a bonus of $2,500. | $2,500 X 0.22 = $550 (bonus tax rate) $354 standard withholding for a monthly earning of $5,000 (based on the IRS 2024 wage bracket tables) | A total of $904 is withheld for taxes ($550 for the bonus tax + $354 for the federal income tax) |
| PROS | CONS |
|---|---|
| Flat withholding rate makes it simple to calculate the tax on bonuses | Requires tracking the total annual bonus amount to identify the correct tax rate on bonuses |
| Has specific tax percentages based on annual bonus amount thresholds | The flat rate for bonus-only payouts may not accurately capture the employee’s income tax rate—this can lead to under or over withholding taxes by year-end (affected workers will need to either pay additional taxes or file a tax refund) |
| Ideal for businesses that prefer to process bonus payouts separately from regular payroll runs | |
2. Aggregate Method
This method is used when the bonus is combined with the regular wages during a pay run but the amounts for each aren’t specified when reporting employment taxes to the government. In this case, the entire amount will be subject to the payroll tax rate and the employee’s tax filing status based on the information listed on their W-4 forms.
| Scenario | Computation | Tax Amount |
|---|---|---|
| Sally is paid a monthly salary, files as Head of Household, and is subject to Standard Withholding. For January, she receives a monthly earning of $5,000 and a bonus of $2,500. | $5,000 + $2,500 = $7,500 (total taxable income) Based on the IRS 2024 wage bracket tables, the standard withholding is $701 for a monthly earning of $7,500. | $701 is withheld for taxes |
| PROS | CONS |
|---|---|
| Offers a better chance of covering the employees’ annual tax liabilities (workers won’t likely have additional tax dues when they file their tax returns) | Can be complicated and time-consuming to compute, especially if you don’t have an in-house staff who knows how to do payroll |
| Great for businesses that prefer to include bonus payouts in regular pay runs | May result to over withholding taxes as it can push an employee’s earnings to the next wage tax bracket (this will require affected workers to file tax refunds with the IRS) |
How to Reduce the Tax Impact on Bonuses
Employees really can’t avoid paying bonus taxes because the IRS considers bonuses as taxable income. Plus, employers are required to automatically withhold the applicable amounts from employee paychecks. However, there are several ways for workers to minimize their tax liability for supplemental wages.
- Use tax deductions: Employees can itemize their deductions when filing taxes and use their bonuses to pay for charitable donations and non reimbursable medical expenses. These transactions can help reduce the workers’ taxable incomes, thereby lowering the tax they need to pay.
- Contribute to a retirement plan or Health Savings Account (HSA): Another way of lowering the taxable income is using the bonus to contribute to an HSA, a 401(k) plan, or a traditional Individual Retirement Account (IRA).
- Defer bonus payout: If employees expect a lower income for the next month or year (either due to an expected retirement or a pay cut), they can request their employers to move their bonus payout to that period. This strategy can help minimize the chance of the worker’s income moving into a higher tax bracket if a bonus is processed.
- Check if the bonus is taxable: While company-paid incentives are considered taxable fringe benefits, non-monetary bonuses and minimal-value fringe benefits are generally non-taxable. Some examples of these items are gift baskets, tickets to theater shows or sporting events, gym memberships, and money for meals if working overtime.
Bottom Line
Processing the applicable bonus tax rate for supplemental wages can be confusing. However, knowing the various calculation methods, including the scenarios on how to minimize tax liabilities, will help you accurately manage bonus payments and potential requests from employees to defer the payout.
If you don’t want to manually handle this, consider partnering with a payroll software provider whose system can accurately process the tax on bonus amounts. To find suitable options, check out our guides to the best payroll software and top payroll services.
