How Bonuses Are Taxed

11/13/24

One of the inaccuracies I hear throughout the year is from those who received a bonus at work. They are frustrated because they say they pay a higher tax rate on that bonus.  

It might seem that way, but that’s not true. It’s simply taxed as regular income. If your bonus is paid out in one lump sum, not combined with your regular paychecks throughout the year and is under $1 million (bummer!), your employer will automatically withhold 22% in federal taxes from that bonus. For many people, this is higher than their normal tax rate.

That does NOT mean that you actually OWE 22% on the full amount. When you file taxes at the end of the year, the IRS will reimburse you for any overpaid taxes throughout the year. While you might have 22% withheld from your bonus, that doesn’t mean you’ll end up actually owing 22%.

In this example, we’ll only focus on federal taxes, since state taxes vary by state.

Bill, who is married, files jointly with his wife, makes $80k per year. His wife is a homemaker. Without any deductions, they will pay in taxes:

-          10% on the first $23,850 ($2,385.00)

-          12% on the remaining $56,150 ($6,738.00)

Bill then receives a $10k bonus at the end of the year, and his employer automatically withholds 22% ($2,200) from the bonus. At the end of the year when Bill files taxes, he will receive $1,000 back because he only needs to pay 12% on that $10,000 bonus. While Bill felt like he was taxed at a higher rate, he was not.

And of course, there’s always the possibility that if you are in a higher tax bracket you’ll owe the IRS at the end of the year. Don’t allocate that money until you know what your tax situation looks like. The key item to remember is this: just because it’s withheld doesn’t mean it’s the amount you owe.

*Please talk with me about your specific situation. Do not use this article to calculate taxes owed or received. I never charge for meetings or advice; I only get paid directly from accounts I manage. I am not a tax professional; I advise in a portfolio management/investment capacity.