What is the bonus tax rate?

If you earned a bonus from work, give yourself a pat on the back. But before you make plans on how to spend it, keep in mind that the IRS generally views a bonus as income, which means it’s taxed. 

Understanding how bonuses are taxed can help so you don’t overestimate or underestimate your total take-home pay. Use this guide to learn more about the bonus tax rate—and how you can determine withholdings on bonuses you may receive. 

Key takeaways

  • A bonus is a type of payment—on top of regular wages—from an employer to an employee.
  • Bonuses are considered income and are subject to taxes
  • Generally the federal bonus tax rate is a flat rate of 22%, but it might be calculated differently depending on the amount and type of bonus. 

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What is a bonus?

In the workplace, a bonus is a financial award given to an employee in addition to their regular wages. Bonus structures differ from company to company. And they might be granted to do things like:

  • Reward exceptional performance
  • Acknowledge a worker’s tenure
  • Incentivize prospective employees to join the company

Just like regular wages, bonuses are subject to taxes. Generally the federal government taxes bonuses at a flat rate of 22%. But bonuses may be taxed differently, depending on their amount and a variety of other factors. 

Types of bonuses

According to the Department of Labor, bonuses may fall into two categories: discretionary and nondiscretionary. Both types are subject to income taxes. 

Discretionary bonuses

As the name suggests, discretionary bonuses are typically given at the discretion of the employer. This means they are excluded from the employee’s regular rate of pay and meet the following criteria:

  • The employer can decide whether to award the bonus to the employee.
  • The employer can decide when to grant the bonus to the employee.
  • The bonus isn’t awarded based on a prior contractual agreement or promise that would lead the employee to expect a financial award.

End-of-the-month bonuses and severance pay are examples of discretionary bonuses.

Nondiscretionary bonuses

Nondiscretionary bonuses are based on standards set by a company. This means the employee understands the requirements needed to receive a bonus. Nondiscretionary bonuses are typically included in the employee’s regular rate of pay. 

Here are some instances when an employee may receive a nondiscretionary bonus:

  • After meeting individual or group productivity goals 
  • For maintaining a certain level of attendance
  • For exceptional and accurate work
  • After a certain number of days without a safety incident

How are bonuses taxed?

When you receive a bonus, your company typically takes money out of the payment to account for federal taxes and sends these funds—also known as tax withholding—to the IRS in your name. Because this is a prepayment on your behalf, the amount you actually owe the IRS may be different when it comes time to file your taxes. 

If the bonus tax rate withholding was higher than your actual income tax bracket for the year, you may receive a tax refund. On the other hand, if you fall into a higher tax bracket than the bonus tax rate withholding amount, you might end up owing the IRS.

Your bonus may also be subject to additional tax liabilities like state taxes, Medicare taxes and Social Security taxes.

Employers can use one of two withholding methods to determine the taxes for an employee’s bonus: the percentage method or the aggregate method. 

Percentage method

The percentage method is typically used for bonuses that are granted separately from an employee’s regular wages—like a discretionary bonus. Bonuses that are under $1 million are taxed at a flat rate of 22%. Bonuses that exceed $1 million are taxed at a flat rate of 22% for the first million dollars and then 37% for anything over that amount.

Aggregate method

The aggregate method is typically used for wages that are paid simultaneously with the employee’s regular rate of pay—like nondiscretionary bonuses. The employee’s bonus and regular wages are combined and taxed at the same rate. The rate depends on the tax bracket the employee falls into once their bonus and regular wages have been combined. 

Is there a way to lower bonus tax liabilities?

Even though it’s not possible to lower the bonus tax rate, there are a few ways to potentially minimize tax liabilities. 

Contribute to a retirement account

Putting bonus money in a tax-deferred retirement account, such as a 401(k) or traditional individual retirement account (IRA), might be a way to reduce income taxes on a bonus. 

Defer the bonus to the following year

In some scenarios, it may make sense to defer a bonus to the following tax year if the employer allows it. For example, if an employee anticipates receiving a lower income next year, they may opt to delay their end-of-year bonus payment. 

Ask for tax advice

The amount of money someone receives as a bonus can change their tax bracket. So it may be beneficial to work with a tax expert or an employer to determine the best options. For example, a tax expert might evaluate the employee’s W-4 and recommend that the employee adjust their withholdings.

Bonus tax rate in a nutshell

Receiving a bonus for the hard work you put into your job can be rewarding and motivating. And once you understand the bonus tax rate implications, you can better determine how you want to spend it—or save it. With a little bit of planning, the funds you receive from a bonus can be used to help you reach whatever financial goals you may have.

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