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.
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.