Your Bonus Isn’t Taxed Higher

Every year around bonus time, inevitably someone will ask why bonuses are taxed at a higher rate than ordinary income.

Every year around bonus time, inevitably someone will ask why bonuses are taxed at a higher rate than ordinary income.

This is the week when Biglaw bonuses are likely to be announced. As the year draws to a close, I’m positive I will have at least one conversation that begins by someone bemoaning the fact “that bonuses are taxed at a higher rate than regular salary”. The problem? It’s not true. There is no such thing as a supplemental tax rate. Bonuses are taxed at ordinary income rates.

Part of the reason why 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 bearing on the actual amount of tax paid each year, but it can be confusing to some.

The internet isn’t very helpful either, with some sites mistakenly declaring the supplemental tax rate to be a 25% 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.

Bonuses are taxed at your ordinary income rate. Interested in determining how much your tax bill will increase upon hearing the good news of getting a bonus? Simply multiply your bonus times your marginal tax rate.

Bonus Wages Are Not Taxed Differently

The IRS considers supplemental wages any wage payments to an employee that aren’t regular wages. They include, but aren’t limited to, bonuses, commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, retroactive pay increases, and payments for nondeductible moving expenses.

Employers and employees have different options on the amount of taxes to withhold on any supplemental wage payment.

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 (not ideal for you as the employee).

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. The result? Employers are required to withhold a flat 25% from the supplemental wage.

If you look at any recent bonus payment, it’s highly likely you’ll see that your the federal withholding on your bonus payment is exactly 25%.

Just to reiterate, this has nothing to do with the actual tax rate applied against those supplemental wages but strictly involves withholding.

Two Different Rates Would Be Impossible To Track

If you think about it, a supplemental wage tax rate doesn’t make any sense either. Why would the government want to tax bonuses at 25%, particularly for high income earners that are in the 39.6% tax bracket? If you’re paying tax that level, 25% 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 “supplementa” as possible.

The same would be true for income earners below the 25% marginal federal tax rate. Everyone would be crying foul and demanding 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, which will include your bonus income.

I hope that puts the issue to rest. Your bonus is taxed as ordinary income, just like all of your other wages.

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Let’s talk about it. Are you often involved in conversations about the tax rate for bonuses? Point them to this article! Let us know what you think in the comments.

Thirty thoughts on Your Bonus Isn’t Taxed Higher

  1. The added supplemental bonus withholding always drives me crazy as I always forget what the rate is which makes it hard to estimate the payout until it occurs. You are 100% correct the tax rate doesn’t change, though its probably so hard for people to pick up because it doesn’t have a separate line.

    1. It’s definitely confusing to people which is why I wrote this up so I could just link to it in the future. I have conversations every year with people about “how bonuses are taxed at a higher rate” which of course just isn’t true.

      1. I work for a small law firm and just received the most amazing $25,000 bonus. Yet the take home was $13,000?. That’s not 25%.

        1. 25% just represents the federal portion of withholding. There could be many other factors that reduce your take home, such as state and local taxes, 401(k) contributions, etc. If your federal tax withholding rate was more than 25%, your firm could be treating the income as regular wages and not supplemental wages. Either way, it won’t affect the amount of taxes you pay in April of next year.

          1. I am sorry, this still doesn’t make sense to me at all. I personally would rather that the government take all of the taxes out that they are going to take up front per the tax bracket that I am.. I had a commission check last year for $13,101.10 The break down was, Fed income:$1,031.10, SST: $812.32, Medicare tax: $189.98, NJ State income tax: $267.24, NJ SUI/SDI Tax $92.37, 401k: 524.07 NET PAY: $10,184.57. That’s not 25%. That’s 22% on everything, not to mention, I thought you said the Federal portion was supposed to be 25%? They only took about 8% federal??? Lastly, because of this and my commission checks throughout the year, separately paid from my salary, my wife and I owed a lot of unexpected money in April. My employees explanation was, In short, the commissions are keyed in as a 9 week payment. They are keyed in this way because it is considered a quarterly payment (not a weekly payment like our weekly pay). What does that mean?

  2. It’s always painful to see so much taken out of a bonus check. But it’s nice to get my money back if there are any overages.

    The payroll tax is hitting income up to $127,200 now. Gotta love Big Government!


    1. How’s not paying taxes working for Texas and Kansas? I always roll my eyes at people griping about how much they think they pay in the U.S. Americans pay nothing.

  3. Thanks for the article. I just experienced this with my first “real” bonus and I was blown away by the 25% withheld. I’m a layman when it comes to this stuff…for the most part. So, whether it’s a withholding or a tax rate, it’s still a huge chunk of money that is going to the federal government and not my bank account. I’m one of the “bemoaners” that you mentioned and to me it’s all the same, just different terminology. Is there legislation that put this into place that could possibly be changed? Has any political party or group tried to change this? I would be interested to know the history of this supplemental wage withholding and what the justification for it was when it was introduced. Not asking you to provide all of that, just venting my curiosity. I’ll be doing some research to find out these answers. I’m not a high earner, I’m in the middle so this is definitely a much larger amount taken out/withheld, by percentage, than I’m used to on my regular pay check. Thanks again for clarifying some of the confusion with this article.

    1. I don’t know the history, but if you find out please come back and update us. I understand your frustration over having no choice in the matter but perhaps think of it as forced savings. When you get that all back on your tax returns it’ll be a nice surprise.

  4. My income or salary gets taxed at 29.62% as tracked by ADP iPayStatements. My bonuses get taxed at 37.8%. The program shows a graph and lists the % of income taxed, taken home and invested. I still don’t understand this even after reading the article.

    1. Remember, we’re talking about withholding (not actual taxes). Everything is taxed the same. I’m not sure why your employer is withholding 37.8% of a bonus check. Are your bonus dollars included in your regular paycheck or in a separate check? If separate, I would think it would be 25%. Maybe worth asking HR.

  5. Good, clearly written post. Even motleyfool got this one wrong (at the end they kind of allude to the fact that the tax rate isn’t actually different, after an entire article explaining how it is):

    My wife’s co-worker just now discussing a bonus also though it was taxed higher. I had a co-worker who thought the same and I always had a sense that come tax time it worked itself out because I recalled nothing in my W2 mentioning my actual bonus (you get at this with the 1040 bit at the end).

  6. @Big Law Investor: Explain to me how bonuses and wages are taxed the same. In calculating the taxes taking out of my most recent bonus, it was 25%. For wages, it was 16% every paycheck​.

    1. Kevin, maybe I can provide an explanation how I am viewing the 25% withholding. For me, it is the way the IRS wants to ensure you don’t under pay your annual taxes because of “supplemental” (additional) income potentially bumping you up into a higher tax bracket. Are they looking out for you? Maybe. Is it a way to bring in tax dollars faster? Possibly.

      Come tax-time, your income (or adjusted income) will determine your tax bracket and the taxes that you have already paid, will be trued-up accordingly (tax refund/tax owed).

      Just my two cents…

      1. It’s a safe harbor for the employer. They withhold 25% because the IRS requires them to do so and the employers don’t have to worry about whether they are under-withholding.

    2. Tax withholding is different from tax paid. Let’s say you make $1,000 per paycheck, and your income tax rate on your tax return is 25%. Theoretically your employer would withhold 25% per paycheck and you would break even when you file your return (no refund, no money owed). However, you could technically ask your employer to withhold all $1,000 and send it to the IRS (let’s ignore employment taxes for the sake of the example). When you file your tax return, you’ll still ultimately pay just 25% tax, and all of the extra tax withheld will be a refund to you.

  7. Just to clarify, by withholding vs tax, you mean what’s withheld throughout the year vs what you actually owe at tax time? I just see it as less money in my account. My employer gives a $250 bonus any time I get a special recognition but my paycheck is only increased by $143 each time I’ve received one. That would mean they’re withholding about 43%. Is that an absurd percentage? My bonuses are included within my regular paycheck. Would I really make that difference back dollar for dollar in my tax return?

  8. I read somewhere, if you’re expecting to receive a bonus, you can submit an updated W-4 form to your employer. On it, you can select tax exempt status. Then after you receive the bonus, submit a new W-4 form with the correct amount of withholdings.

    Any idea if that’s legal?

  9. I am receiving about 5 years of back pay, which counts as supplemental income and will be taxed at a flat rate of 22%. This backpay along with my income for the current year will put me in the 35% tax bracket (i’m single) when it’s time to pay. This is going to lead me to owe tens of thousands of dollars when tax time comes. What kind of professional should I talk to help me with trying to get my AGI lowered or should I just adjust my W2 to withhold more of my regular income throughout the year? or perhaps find a single woman to sign a prenup, marry her and divorce her afterward after I file. (it looks as if that would save me $33k in fed taxes) If Income and Supplemental income are both taxed at the same rate at the end of the year, why are they withheld so differently?

  10. After seeing an email from HR about the bonux “tax rate” I thought “huh?” — I had to look through a ton of crap on the internet that kept indicating the different rate exists but I knew this was simply not true. Thank you for the article that puts my mind to rest. Who cares what your withholding is, all that matters is the actual tax at the end of the day.

    And for low income earners who complaint, fix your W4 appropriately and quit giving the IRS a free loan.

  11. Thank you! I keep trying to tell my husband this, but he insists on believing what his general manager at work told him.

  12. Thanks for the clear and helpful answer to my question! Trying to figure out if my bonus was getting taxed at a higher rate. While I’d like to have all of my money now I also like getting a larger tax refund.

  13. Thanks for clarifying this point. I think people are getting confused with “Withholding” versus “Actual tax” being paid in April. It is true that the Withholding may be higher depending on how the company processes it, but at the end you pay the same amount of tax. I recently got a bonus and was worried, but when I checked my W2, Box 1 was just salary+bonus-deductions. So you are absolutely right, that the bonus actually gets taxed at the same Income Tax rate.

  14. @BigLawInvestor, marvelous article. Does the same logic apply to RSU Vested amounts as well? Say I made $1000 in regular wages, and $200 in vested RSUs in 2018, I thought a flat 22% tax rate is applicable to $200 and the $1000 is taxed at the brackets stuff. ?

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