According to the IRS bonus definition, a bonus is additional financial compensation that goes beyond the normal expectations of an employee or executive. Bonuses can be distributed for a variety of reasons, one of the foremost being exceptional work. They can also be used as incentives for employee retention.
While bonuses are subject to income taxes, they aren’t simply lumped in with your income but are treated a bit differently.
How Are Bonuses Taxed?
Bonuses aren’t taxed according to marginal income tax rates as they are considered “supplemental income.” Instead, the IRS uses bonus tax rates. When looking at how bonuses are taxed, you’ll typically find that bonuses are subjected to a 22% flat rate. For instance, if you receive a $1000 bonus, you’ll have to pay $220 in taxes.
This said, if you receive a very large bonus, say over $1 million, any money received over the one million mark will be subject to a 37% tax rate. For example, if you receive a $1.5 million bonus, one million of that will be taxed at 22%, while the rest will be taxed at 37%, for a total tax of $405,000.
How Does a Bonus Affect Your Tax Rates?
Just as an employer can withhold money from your paycheck for taxes, they can also withhold money from your bonus. This is called tax withholding, and any funds held in this manner are sent to the IRS on your behalf.
With bonuses, employers can calculate withholdings with the percentage method or aggregate method.
The percentage method is the easiest of the two. They simply identify the bonus as different from your income and calculate withholdings using the rates mentioned above. Note that Social Security, Medicare, and state income taxes may also be withheld.
The aggregate method involves the employer paying bonuses alongside your wages, withholding taxes based upon your tax bracket. The initial tax withholding with this method is usually higher.
If you would like to learn more about how taxes work, contact Tax Help MD today. Our professionals know the law backwards and forwards and can’t wait to help you understand taxes better. You can also schedule an appointment for a free consultation.