Are Bonuses Taxed? How Bonuses Are Taxed and Treated by the IRS

Bonuses are an excellent way to motivate employees and reward top performers. However, bonuses can also quickly change one’s tax return and the amount of taxes initially withheld depending on the payout.

Are bonuses treated as regular income or singled out for special tax treatment? Are some types of bonuses more favorable than others? And are there any ways to minimize the tax impact of getting a bonus? These questions are explored below.

Bonuses are considered “supplemental wages”

The IRS goes to great lengths to categorize different types of income and treat them differently, and bonuses are another example of this. In the eyes of the IRS, bonuses are typically categorized as “supplemental wages.” As a University of Minnesota summary explains:

“The IRS defines supplemental wages as compensation paid in addition to the employee’s regular wages that includes, but is not limited to, severance or dismissal pay, vacation pay, back pay, bonuses, moving expenses, overtime, taxable fringe benefits, and commissions.”

Are your bonuses taxed?

If you recently received a bonus, you may be wondering — are bonuses treated the same as your taxable income, or are bonuses taxed differently?

One way or another, bonuses are typically taxed, but how they are taxed and at what rate depends on the situation. Tax rates may also vary based on your tax bracket and the type of bonus you receive.

So, how are bonuses taxed? We’ll take a closer look at that in the rest of this guide.

Are bonuses taxed on the federal and state levels?

Bonuses are usually taxed on both the federal and state levels, which means you have to report and pay taxes on your bonuses twice. However, supplemental income tax rules and rates can vary depending on the state you’re in.

You can visit your state Department of Revenue website to learn more about how bonuses are taxed in your state. If you need help finding tax information for your state, you can use this state Department of Revenue directory.

How are bonuses taxed?

Bonuses (like other supplemental wages) are treated differently than ordinary wage or salary income when it comes to taxes withheld at payout. There are two ways of withholding taxes from your bonus: the percentage method and the aggregate method. Which method gets applied to your bonus? Let’s find out.

The percentage method

The IRS specifies a flat “supplemental rate” of 22%, meaning that any supplemental wages (including bonuses) should be taxed in that amount. If you receive a $5,000 bonus, under this rule, $1,100 (22% of $5,000) goes straight to the IRS. Using this approach, the amount of your bonus, whatever it is, is “singled out” from the rest of your income and taxed directly.

Employers frequently choose the percentage method because it’s easier to tax the entire bonus at a uniform rate. In most cases, this is ideal from your standpoint as the bonus receiver and taxpayer, too. In addition to being more time-consuming and laborious for employers, the aggregate method (described below) can take a bigger tax bite out of your bonus payments.

The aggregate method

Unlike the much simpler percentage method, the aggregate method is used when your employer pays your bonus (say, $5,000) with your most recent regular paycheck. Then, they determine the normal withholding amount based on IRS withholding tables for the sum of both amounts, subtract what was already withheld from your last paycheck, and withhold the rest from the bonus amount.

The problem with this approach is that instead of taxes being withheld at a flat 22%, and having that 22% rate applied only to the bonus amount, taxes are withheld at what is almost certainly a higher rate on the combined amount of your normal pay and the bonus. The result: a higher overall tax obligation initially for the same amount of income.

Also, if your bonus puts you in a higher tax bracket this year, and you expect to make less next year, see if your employer can defer your bonus to lower your tax bill this year.

Now, you might be asking, “Why are bonuses taxed so high?” and that’s understandable, but luckily, there are a variety of ways you can reduce your taxable income overall, like taking advantage of credits and deductions.

What if my bonus exceeds $1 million?

What about high-end corporate bonuses, like those exceeding $1 million or more? These are singled out for higher taxes. If you receive a bonus of more than $1 million, your employer must withhold 37% of the amount above $1 million, as well as the standard 22% of the amount below $1 million. In short, if you dislike the eye-popping bonuses top executives receive, you can take comfort in knowing how large a bite the IRS takes!

No matter what method is used to withhold taxes from your bonus at payout, don’t panic. Remember, taxes may be withheld from your bonus at a higher tax rate at payout, but when you file your taxes at tax time, your actual tax rate is based on your total taxable income and overall actual tax rate, which may be lower. 

Depending on your taxable income, actual tax rate, and eligible tax deductions and credits, you may get some of the money withheld back in the form of a tax refund.

When are bonus taxes paid?

If you received a bonus from your employer, you don’t have to worry about withholding taxes or reporting additional income at the end of the year. Taxes from bonuses are usually withheld before you receive your bonus.

What happens if you overpaid or underpaid taxes on your bonus?

Even though you don’t have to withhold and pay taxes on bonuses manually, you can still overpay or underpay taxes on your bonus.

If you overpaid your taxes, you could be eligible for a refund at the end of the year. However, you’ll only receive a refund if you have enough withheld for federal taxes and you don’t have any outstanding tax bills.

If your employer doesn’t withhold enough when paying your bonus, you may have an unexpected bill when you file your taxes. You can also face penalties for underpayment in some cases. Fortunately, this usually isn’t a problem.

Don’t worry about remembering all of this information come tax time, TurboTax will ask you simple questions about you and give you the tax deductions and credits you are eligible for.

Are you lucky enough to get a bonus? Which tax method will your employer use?