Congratulations on your recent bonus. This money is a meaningful part of your earning structure and you probably have a number of ways you’d like to spend it. Before you make too many plans, it is important to understand how it will be taxed and how much of the balance you’ll see in your paycheck.
According to the IRS, your bonus is classified as supplemental wages. Keeping this in mind, there are a number of factors that impact the ultimate amount you’ll be able to spend immediately. Many people are surprised to find out how much their bonus goes towards tax withholding when they receive it.
Luckily, there often is good news. As an article from The Balance explains, many people see this money return to them in the form of a refund when they process their annual tax returns.
Employer decisions impact withholding amounts
How your employer defines your bonus makes a difference. If your employer categorizes your bonus as part of your regular income, the IRS should withhold money on the total amount of dollars that are earned in that pay period–just as if it were regular wages. This is a simpler option.
If your employer categorizes your bonus separately, the IRS will review if your employer withheld taxes during the current or previous year. If your employer withheld taxes there are two options for what to do with your current bonus. Option A allows withholding on a standard rate of 22 percent regardless of your tax bracket. Option B is a more complicated aggregate method that calculates taxes for your bonus in the context of taxes for your regular pay. Alternatively, if your employer isn’t withholding taxes on your regular pay, and hadn’t done so in the previous year, option B is the only possibility.
Other impacts on your bonus
Just like your regular pay, your bonus is subject to other withholdings including social security, Medicare, and state income taxes. In addition, because your bonus is also included as part of your annual pay, it may push you into the next highest tax bracket.
The way bonuses are taxed is not always easy to understand. If you have any questions, contact your employer’s HR department or a financial services professional. They should be able to help you have full confidence that the amount of your bonus that you take home is as it should be.