Bonus Tax Rate for 2023: How the IRS Taxes Bonuses
March 01, 2023
Taxes can leave quite the dent in your income and your daily expenses. You’ll probably be shocked to learn that even the bonuses given by your boss are taxed.
But before you lose your marbles, why not take the time to learn all about them first? This article will explain all about the bonus tax rates, how they are taxed, how to withhold bonuses, and how you can reduce the effect of taxes on the bonuses you receive at work.
Let’s get straight into it!
- Bonus tax rates are taxes withheld from cash bonuses awarded by employers to their staff.
- The IRS considers bonuses as a form of income, particularly a type of supplemental wage.
- The tax rates imposed on cash bonuses are 22% for bonuses not exceeding $1 million and 37% for bonuses worth more than $1 million.
- The percentage method withholds bonus tax rates by using the 22% and 37% flat rates imposed by the IRS.
- The aggregate method considers the bonus as an addition to the employee’s regular monthly income.
- To reduce the impact of taxes on your bonuses, you can either update your W-4 Form, check other tax deductions, donate, or ensure that your bonus is indeed taxable.
What is a Bonus Tax Rate?
A bonus tax rate is a tax imposed on compensation awarded by employers to their employees on top of their regular wages. There are several different ways an employee becomes entitled to a bonus, depending on their company’s policies.
It may be performance-based, or it can also be based on their tenure in the company. The bottom line is that the IRS considers bonuses to be a form of income. Hence, it is not exempt from tax withholdings.
In fact, bonuses are categorized as a type ofsupplemental wage, or wages that are not included in your regular pay and may vary for each pay period.
Other examples of supplemental wages include overtime pay, accumulated sick or vacation leave, tips, retroactive pay increases, and commissions.
How Do the IRS Tax Bonuses?
The general rule for imposing taxes on employee bonuses is that bonuses worth $1 million or less are subject to the standard 22% withholding flat rate. Anything exceeding $1 million, especially a one-time bonus check, will be subject to a 37% withholding tax rate.
FICA taxes may also be withheld from bonuses: 6.2% for Social Security and 1.45% for Medicaretaxes.
Federal tax withholding rules may vary in determining how much should be withheld from employee bonuses. That is because bonuses are not considered regular pay but are instead included in supplemental wages.
For instance, if an employee receives a $10,000 bonus for the entire year, they are subject to a 22% withholding tax rate because the amount is less than $1 million.
That means the employer withholds $2,200 from the employee’s bonus alone. ($10,000 X .22 = $2,200)
Lastly, state tax rates will depend on where the employee’s work is located.
How to Withhold for Bonuses
Employers have two options for withholding bonus tax rates:
#1. Percentage Method
The percentage method is applicable to bonuses that are given apart from the regular salary or wage of an employee. This type of bonus is usually based on the employer’s discretion, meaning that it is not bound by any prior contractual agreement between the company and the staff.
To use the percentage method, use the tax withholding percentages described above. The withholding rate of 22% applies, provided that the bonus does not exceed $1 million.
Withholding rates increase to 37% if the employee receives a bonus of more than $1 million. For example, if the employer grants a bonus worth $1,500,000, then the first $1 million is subject to 22% of tax withholdings, while the remaining $500,000 is subject to a 37% tax withholding rate.
#2. Aggregate Method
The aggregate method best suits nondiscretionary bonuses. Nondiscretionary bonuses are included in employees’ regular pay and are based on a specific set of rules and standards established by the company.
Some common standards that merit a nondiscretionary bonus include perfect attendance, meeting a specific set of employee performance metrics, or not incurring any violations or errors at work for a given period.
To calculate the bonus tax rate under the aggregate method, employers must use their employees’ tax bracket as the basis.
Here’s an example for you to better visualize how the aggregate method works:
If an employee who is a single filer is paid $8,000 for their monthly salary, that would incur an annual rate of $96,000. Based on the tax brackets for 2023, the employee falls under the 32% tax withholding rate.
Then, the employee receives a $5,000 bonus on top of their monthly salary. Since the bonus in this example is given alongside the employee’s regular salary, the employer will combine the $5,000 bonus with the employee’s monthly salary, $,8000, to yield $13,000.
Next, the employer multiplies the combined amount of $13,000 by 12 to arrive at a presumed annual income of $156,000. This means the employee’s tax withholding rate goes up to 37%.
Differences Between the Percentage and Aggregate Method
Using the percentage method could initially mean that a higher bonus amount goes into the employee’s pockets. However, calculating bonus tax rates through the percentage method is relatively easy on the part of the employer.
Meanwhile, the 22% flat rate is not applicable to all employees, particularly those earning higher annual incomes. In other words, the tax rate withheld from the employee’s bonus and regular wage may not be enough to cover their tax liabilities.
Employees whose earnings place them under a higher tax withholding rate may expect an additional tax bill for any unpaid tax responsibilities. Conversely, employees in a lower income tax bracket are likely to see higher tax rates imposed on their bonuses.
The aggregate method means withholding a higher amount from the employee’s regular wage and bonus. It also ensures there is enough to cover the employee’s tax obligations.
Since a higher amount of tax liabilities are covered, there is a higher chance of having zero back taxes. Better yet, the employee may also be entitled to a tax refund.
How to Reduce the Impact of Tax on Your Bonuses
Here are five different methods that will help you regulate the impact of taxes on your bonuses:
#1. Maintain Your W-4 Form
Your bonus tax rates are based on your tax bracket and the information you have provided in your W-4 Form. The W-4 Form declares how much tax is to be withheld from your salary based on your filing status, enumerates your dependents (if any), and specifies any deductions and expected tax credits.
By checking your W-4 Form and updating the information you’ve provided as needed (for example, you recently got married or are having a child), you can calculate your withholdings in advance and determine whether you may be eligible for a tax refund or subject to a higher tax liability.
#2. Take Tax Deductions Into Account
Getting more familiarized with your specific tax deductions gives you a clearer idea of how much you can adjust when it comes to your bonus tax rates.
You can check your standard deductions or the portion of your regular income not subject to tax withholdings. Alternatively, you also have the option to check whether you have medical or dental expenses that have not been reimbursed.
Non-refunded medical or dental expenses may be itemized on your tax return to help reduce your taxable income.
#3. Use Your Bonus Toward a Contribution
Donating and contributing to non-taxable organizations is an effective way to regulate the tax rates withheld or deducted from your regular pay.
Depending on where you give your donation or the organization where you have sent contributions, you can deduct a minimum of 20% and a maximum of 60% from your amended gross income.
Make sure your donations go to qualified organizations, and document all your contributions. Like your adjusted tax deductions, you have to itemize your documented donations in your tax return under Form W-4, Schedule A.
#4. Put off Your Bonus for Later
If you feel that your bonus might bump you up to a higher tax bracket and predispose you to a higher tax deduction, you can ask your employer to put off your bonus for next year.
You can also seek advice from a professional or discuss with your employer any other options and adjustments to reduce the deductions and ensure you get to maximize your hard-earned bonus.
#5. Ensure Your Bonuses are Taxable
Not all bonuses given by your employer are taxable, at least by IRS standards. An example of this is if you receive plaques of recognition, event tickets, meals, or gift cards as a reward.
These are not exactly monetary bonuses, and their value is not high enough to be considered for a tax deduction.
What was the Bonus Tax Rate for 2022?
In 2022, the bonus tax rate was set at 22% for employee bonuses not exceeding $1 million. It’s the same bonus tax rates carried over for the 2023 tax year.
Employees who received bonuses that amounted to over $1 million were subject to a 37% tax rate. Calculating the bonus tax rates for 2022 also used either the percentage or aggregate method.
Understandably, it may seem discouraging that even cash bonuses given at work are still subject to tax deductions.
The best way to go about this is to ensure the correct amount is withheld from your bonus and determine whether any of the alternatives listed above would help reduce your tax withholdings.