How Are My Bonuses Taxed?

Dear Kristin,

My boss and I had to fight hard this year to get my team the compensation increases they very much deserved, and what came back was small base salary increases offset by larger increases to bonus/commission. I've always heard that bonuses are taxed at a higher rate (and I even read The Balance's article on this topic!), but I'm still a little confused.

The way I'm reading it—the amount that comes out in your paycheck initially is higher, but when you do your taxes at the end of the year, the income isn't actually treated any differently than your regular salary—is that right? So hypothetically, you might get those extra taxes back? Obviously it could push you into a higher tax bracket, but arguably so would a higher base salary. Also, are there any differences as it relates to state/local taxes in NYC? I would love to have a clear answer to give my team on this topic! Thank you so much!! 

Sincerely,

Anxious Boss in NYC

Dear Anxious,

This is a great question and honestly it’s one that I have asked myself whenever I’ve been fortunate enough to get a bonus! First of all, it’s nice to see a boss fighting for their employees to get the pay they deserve. The quick answer to your question is… it depends how your employer taxed the bonus when they distributed them.

Let’s step back. Based on how much you tell your company to withhold from your paycheck, your employer will take a portion of your salary and send it to the government to pay your taxes. That’s the W-4 form you fill out when you’re hired. This doesn’t change when you get a bonus, and your employer will still take out a portion to send to Uncle Sam. What can change is the size of the portion the government gets.

Any bonus is considered supplemental income, which is taxed at 22%, and that might be a lower tax rate than you’re used to, depending on your current salary. That’s up until the bonus reaches $1 million. After that, supplemental income is taxed at the highest income tax rate possible, which is currently 37%.

Your employer has two options to withhold the appropriate level of tax: They can either withhold 22% of the bonus (the percentage method) to give to the IRS, or they can treat it as regular income (known as the aggregate method) and tax you at your usual income tax rate. There's a wrinkle, though. For the aggregate method to work, your employer must bundle your bonus with your regular paycheck. 

In my personal experience, a lot of jobs go with option #2 and treat your bonus as your regular wage. You might notice that when you get your bonus, it’s taxed more than what you’re used to. And the reason for that is because you're receiving more money than usual, so you’ll be taxed more than usual. 

But it’s still a supplemental wage that should be taxed at only 22% (assuming your bonuses are less than $1 million). So if your money was taxed at a rate higher than that, you could be eligible for a refund when you file your tax return the next year, as long as you don’t underpay taxes elsewhere.

You asked if local taxes come into play, and the answer is yes. New York State withholds supplemental wages at an 11.7% tax rate (and NYC will get its usual cut), but for our readers in other states and cities, check your local government tax regulations to see how you’ll be impacted.

It’s great that you were able to negotiate bonuses for your employees, but don’t stop fighting for bigger base salary increases. Unless your employer promises to give these bonuses regularly, they go away after they’re given, and it sounds like what your team really wants is to get paid fairly. And the only true way to do that is to make sure that their regular, consistent income reflects what they’re worth.

Good luck!

-Kristin

If you have questions about money, Kristin is here to help. Submit an anonymous question and she may answer it in a future column.