Holiday Bonus Season: How Your Holiday Bonus is Taxed

Tax Planning twenty20_438ae55e-c533-4b07-8cca-5fd98d2cd1f5

December is a time for giving gifts, and some employers give year-end bonuses to their employees, to show gratitude for a year of faithful service. If your employer has promised you a bonus, you likely are already thinking of all the uses you have for the money. But before you get carried away, remember that holiday bonuses are considered compensation, just like paychecks, and so there will be taxes withheld from your bonus—plenty of them. There may be other reductions as well.

How big a bite will these withholdings take? Let’s take a look.

Social security tax. You pay social security tax on all compensation up to $118,500 of income for the year. If you haven’t yet exceeded that ceiling, then expect your employer to deduct 6.20% from your bonus for social security.

Medicare tax. You pay Medicare tax on all your compensation, so another 1.45% will be deducted for Medicare tax.

Federal income tax. The IRS typically requires federal income tax of 25% to be withheld from supplemental income such as bonuses. Your employer has the option to aggregate your bonus with your regular paycheck and withhold taxes on the whole shebang, which likely will result in even higher withholding than 25%. But don’t worry, the money may not be lost. Since tax rates on supplemental income may be higher than your actual tax rate based on your total income when you file at tax time, you may get some of it back as part of your federal tax refund when you file your taxes.

TurboTax has a bonus calculator you can use to see how much federal income tax will be withheld from your holiday bonus.

State income tax. If your state imposes an income tax, and most states do, state income tax will be withheld at whatever rate required by state law.

Retirement plan contributions. If you have asked your employer to withhold a percentage of your wages as a contribution to your 401(k) or other contributory retirement plan, it is likely that same percentage will be withheld from your bonus. So if you have requested that 15% of your paycheck go into retirement, then 15% of your bonus may go there as well. This will be good news when you retire with a bigger nest egg than you would have had otherwise, but it will pinch a bit in your wallet now.

Add these all together, and that’s how much may be withheld, but the good news is you are getting a bonus and may get some of  it back when you file your taxes.

Don’t worry about knowing these tax rules.  TurboTax will ask you simple questions about you and give you the tax deductions and credits you deserve based on your answers.

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