Calculating your bonus tax rate may seems like a prudent move with bonus season right around the corner. I see this issue confuse people time and time again, with most people assuming that bonuses are taxed at a higher rate than your regular salary.
Let’s put the myth to rest immediately:
Your bonus isn’t taxed at a higher rate.
That’s right. Surprised?
Bonuses are taxed at the same ordinary income tax rate.
Part of the reason this myth persists is because bonuses and other types of supplemental income are subject to different rates of withholding.
Of course, the amount withheld from your paycheck has no relationship to the actual amount of tax paid each year, but it can be confusing to some. If your employer withholds too much money, the Internal Revenue Service will be giving you the money back next year in the form of a tax refund after you’ve filed your tax return.
The internet isn’t very helpful either, with a lot of websites mistakenly declaring the supplemental tax rate to be a 22% flat tax. Again – there is no such thing. I would link to the sites I’m talking about, but I don’t want to give them any more exposure then they already have.
What’s your income tax on bonuses?
If you’re wondering how bonuses are taxed, I’m going to explain it in this section.
But first, you need to understand that the IRS considers supplemental wages to be any income paid to an employee that aren’t part of your regular wages in a regular paycheck.
That means most bonuses are supplemental wages.
When your employer makes a supplemental wage payment to you (i.e. bonus), they have two options for how to treat your bonus.
If the supplemental wage is combined with regular wages and there’s no indication as to which part of the payment is regular wages and which part is supplemental, then the employer withholds as if the total was a single payment for a regular pay period.
That means if you are normally paid $5,000 a month and get a bonus in one month for $5,000, the IRS will treat you as if you’re making $120,000 a year (not ideal for you!).
Most employers don’t like this option either, so it’s not very common.
The vast majority of employers make it easy on themselves and separate the supplemental wages from the regular wages.
This is why you’ll often get one paycheck with your salary and a separate paycheck with your bonus.
If this is how your employer handles bonus payments, they’ve separated your “regular” wages from your “supplemental” wages.
Employers are required to withhold from your paycheck a flat rate of 22% of the bonus payment. (i.e. the withholding rate).
If you look at any recent bonus payment, it’s highly likely you’ll see that your federal withholding on your bonus payment is exactly 22%.
Just to reiterate, this has nothing to do with the actual bonus tax rate. This is only the amount that your employer is withholding and sending to the government and tax withholding is not the same as the total amount of taxes paid.
Bonuses, like regular income, are subject to medicare and social security taxes, so your bonus check should show deductions for medicare taxes in addition to the the deductions for federal income tax and state taxes (state income taxes vary by state so there is no single answer for how much will be withheld from your paycheck by the state – check with a tax professional in your area to be sure).
How to calculate your supplemental wages bonus tax rate
Calculating your actual bonus tax rate in a typical tax year isn’t that hard.
Your bonus is taxed at the same rate as all of your other income.
If you’re in the 33% tax bracket and you receive a bonus of $100,000, you will pay $33,000 in federal taxes.
The state and local taxes work the same way. Multiply the bonus amount by your marginal tax rate to understand how much you will pay.
Since your employer may withhold more or less than the actual amount you will pay, this will get sorted out when you pay your taxes.
If your employer withholds more than your marginal tax rate, you may get a refund when you file your tax return.
If your employer withholds less than your marginal tax rate, you may have to pay when you file your tax return.
A bonus tax rate would be impossible to track
If you think about it, a bonus tax rate doesn’t make any sense either. Why would the government want to tax bonuses at 22%, particularly for high income earners that are in the 39.6% tax bracket?
If you’re paying tax at 39.6%, 22% on your bonus doesn’t sound so bad. In fact, it would encourage all high income earners to insist that their employers classify as much income as “supplemental” as possible, therefore reducing their taxable income and resulting in less tax liability.
The same would be true for income earners below the 22% marginal federal tax rate. Everyone would be crying foul and demand that bonuses get included in regular wages (to be fair, people do complain but only because they misunderstand the difference between the withholding and the actual tax due).
Finally, there’s no place on Form 1040 to include bonus income. Line 7 requires all wages, salaries, tips, etc. as reported on your W-2.
Since there’s no place to put bonus income on your 1040, there’s no way for the IRS to tax your bonus at a higher rate!
I hope that puts this personal finance issue to rest. Your bonus is taxed as ordinary income, just like all of your other wages.
Joshua Holt is a practicing private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He knows that the Bogleheads forum is a great resource for tax questions and is always looking for honest advisors that provide good advice for a fair price.