[ad_1]
So, you received a bonus at work? Congratulations. Whether it’s a year-end bonus or a reward for strong performance, a planned or an unplanned bonus, any extra money can be a great reward. Before you start thinking of all the ways you want to spend this extra compensation, it’s important to realize that the IRS is going to take a fraction of your bonus.
How are bonuses taxed, and how much will the IRS take out of your bonus? The answer to these questions depends on several factors. Keep reading to learn more about how bonuses are taxed and what steps you can take to minimize this tax burden.
In This Piece
- How Are Bonuses Taxed?
- Methods for Paying Taxes on Your Bonus
- What You Can Do With Your Bonus Instead
- Preparing for Tax Season
How Are Bonuses Taxed?
The IRS views bonuses as a form of income. However, not all income is taxable. When filing your taxes, you need to know which types of income are taxable and which aren’t. For example, do you owe taxes on unemployment? No, the IRS doesn’t tax unemployment payments. Do you owe taxes on bonuses? Yes, because bonuses are considered a form of supplemental income. At the end of the year, you must include your bonus as part of your annual income when filing your taxes. This means the actual amount of taxes you pay on your bonus money is based on your tax bracket.
Besides federal taxes, your bonus money is also subject to Medicare and Social Security withholdings. Additionally, depending on which state you live in, you may need to pay state taxes on your bonus income.
Methods for Paying Taxes on Your Bonus
How much are bonuses taxed? The exact answer to this question depends on your employer. The IRS gives employers two methods they can use when determining how much tax to withhold when disbursing your bonus payment. Employers can use the percentage method or the aggregate method.
The Percentage Method
The percentage method is the easiest and most common option employers use when disbursing bonuses. With this method, your employer will send you a separate payment just for your bonus. Your employer will also deduct a flat 22% from your bonus for federal taxes. If your bonus is over $1 million, your employer will deduct 22% from the first million dollars and then 37% for any part of the bonus over $1 million.
This doesn’t mean you actually owe 22% of your bonus in federal taxes. Rather, your actual tax liability depends on your taxable income and tax filing status. Depending on your specific situation, you may receive a tax refund if your tax withholdings were too high.
The Aggregate Method
With the aggregate method, your employer includes your bonus on your regular paycheck. For example, if you typically earn $3,000 per pay period and your employer gives you a $5,000 year-end bonus, you’ll receive a check for $5,000. With this method, your employer withholds taxes based on the information listed on your W4 form, such as any deductions and tax filing status.
Do Bonus Checks Contribute to Your Tax Bracket?
The added money on your paycheck could push you into a higher tax bracket. If this happens, your employer may withhold too much. However, you can obtain a refund for any taxes you overpay.
What You Can Do With Your Bonus Instead
There are several things you can do to minimize the tax implications of receiving a bonus at work and secure a higher tax refund. First, you can transfer all or a portion of your bonus to a tax-advantageous account, such as a 401(k), traditional IRA or Health Savings Account. Because contributions to these accounts are pre-taxed, you won’t have to pay federal tax on the amount you transfer.
Keep in mind that you’ll owe taxes when this money is distributed. Additionally, the government sets limits on how much you can contribute to these accounts each year. So, you must make sure any contributions comply with these guidelines.
Secondly, if you know you’ll earn less money next year, you can ask your employer to defer your bonus payout. For example, if you plan to go on extended maternity leave next year or retire in a few months, you can ask your employer to wait until next year to issue your bonus.
Not all employers are willing to agree to this option because they may want all bonuses disbursed in the current year. However, if your employee will defer your bonus payout, you can lower your tax burden because you’ll have less taxable income in the next year.
Preparing for Tax Season
One of the best things you can do to minimize your tax burden every year is conduct an annual review of your W4 to make sure the information is correct. For example, check your filing status, dependents and other adjustments. Your employer uses this information to determine your tax withholdings, so it’s crucial to make sure this information is correct.
It’s important to know how to do taxes yourself step by step. Understanding this process can help you minimize your tax burden by making sure you take advantage of all the tax credits and deductions you can. After all, does the IRS catch every mistake? Of course not. This means that if you haven’t done your research, you could miss out on tax deductions that could save you money.
Alternatively, you can have a professional complete your taxes to ensure they’re done right. Credit.com can provide more tax-friendly tips and show you how to get a bigger tax refund.
The post How Are Bonuses Taxed and Who Pays? appeared first on Credit.com.
[ad_2]