How Are Bonuses Taxed?

Are employee bonuses taxable?

Yes, employee bonuses are considered taxable income; they are subject to federal and state income tax withholding. In the eyes of tax authorities, employee bonuses are another form of employee income. However, withholdings for bonuses are calculated differently than withholdings for regular wages.

What is the bonus tax withholding rate?

The bonus tax withholding rate is an optional flat rate that businesses can choose to use for bonuses that are identified separately from employee wages. The 2024 bonus tax withholding rate is 22 percent. Above $1 million, this rate rises to 37 percent. 

That means that if you pay an employee a bonus of more than $1 million, there is a 22 percent tax withholding rate on the first million dollars you pay an employee in one year and a 37 percent tax withholding rate on everything above that.

In addition to the federal bonus tax withholding rate, you must withhold Social Security, Medicare and state taxes from bonuses.

How do employee bonus taxes work?

As an employer, you must withhold three types of taxes from employee bonuses: federal income tax, Federal Insurance Contributions Act (FICA) tax and state tax.

Federal income taxes for bonuses

Federal bonus taxes are calculated differently depending on whether they are given to employees with their regular paychecks or separately. 

If you issue bonuses via paychecks that are entirely separate from your employees’ usual paychecks, you have the option to withhold taxes at the federal 22 percent flat rate. This is called the percentage method. If you add your employees’ bonuses to their next regularly scheduled paycheck, you must use the aggregate method. We’ll explain each method below.

FICA taxes for bonuses

In addition to federal income tax withholding, bonuses are subject to FICA taxes, which are the withholdings for Social Security and Medicare. The 2024 Social Security tax rate on wages and other supplemental income, including bonuses, is 6.2 percent on the first $168,600 you pay each employee. The 2024 Medicare tax rate is 1.45 percent on all wages, including bonuses, under $200,000. If you pay in excess of $200,000 to an individual in a calendar year, including bonuses and other supplemental income, you must also withhold 0.9 percent for the Additional Medicare Tax.

State taxes for bonuses

Most states assess taxes on bonuses. Some states even have different bonus tax withholding rates for different types of bonuses. In California, for example, the state supplemental wage tax rate is 6.6 percent and increases to 10.23 percent on bonus and stock options. In Maryland, you add your local tax rate to the 5.75 percent state bonus tax rate to calculate the state bonus tax withholding. Consult a list of state bonus taxes to determine your withholding requirements.

How to calculate bonus tax withholding

Whether you qualify to use the flat tax withholding method or the aggregate method for bonus tax withholding depends on how you paid the bonuses and whether you have been withholding tax from the employee’s pay.

• Flat percentage bonus tax withholding method: If you make separately identified bonus payments to employees and you have withheld income tax from the employee’s regular wages in the current or preceding year, you have the option to use the flat percentage method.
• Aggregate method: Use the aggregate method if you meet at least one of these criteria:
  • You pay bonuses not identified separately from regular wages.
  • You did not withhold tax from the employee’s wages in the current or preceding year.
  • You make separate bonus payments but you choose to use the aggregate method.

Tax liabilities and the percentage method

Let’s say your company is based in a Colorado city with no local bonus tax withholding and you pay an employee a $1,000 bonus that is delivered via check or direct deposit and is identified separately from a regularly scheduled employee payment. In this case, you have the option to calculate the federal bonus tax using the percentage method.

Follow these steps to calculate tax withholding using the percentage method: 

1. Start with the 22 percent federal bonus tax withholding.
   $1,000 x 22 percent = $220 in federal bonus tax withholding
2. Calculate FICA tax withholding. 

$1,000 x 6.2 percent = $62.00 Social Security tax

$1,000 x 1.45 percent = $14.50 Medicare tax

$62.00 Social Security tax + $14.50 Medicare tax = $76.50 total FICA withholding

If you pay an employee more than $200,000 in a calendar year, you also must withhold 0.9 percent for the Additional Medicare Tax.

3. Calculate the state bonus tax withholding.

Use Colorado’s 4.63 percent state bonus tax rate: $1,000 x 0.0463 = $46.30 Colorado state bonus tax withholding

4. Add all bonus tax liabilities. 

$220.00 federal income tax withholding + 76.50 total FICA withholding + 46.30 state income tax withholding = $342.80 in total bonus tax withholding. The net bonus you issue to your employee equals $657.20 ($1,000 – 342.80 = $657.20).

Tax liabilities and the aggregate method

If you use the aggregate method instead of the bonus tax withholding rate to calculate tax withholding, you use standard federal income tax withholding tables. 

In our previous example, say you use the aggregate method. If you give a $1,000 bonus to an employee whose usual monthly salary is $6,500, you’re effectively paying this employee $7,500 for the month. Using tax withholding tables (IRS Publication 15-T), determine tax withholding the same way you would if the $7,500 were a regular monthly paycheck. Using the monthly table for a single filer, standard rate, paid monthly, with a W-4 form filled out in 2019 or later, the withholding amount on the combined salary and bonus would be $976.

If you use payroll software, enter the total amount of bonus and regular salary in the program, and the correct amount of tax will be withheld.

The FICA tax and state bonus tax calculations remain the same.

How to use the aggregate method if there are no concurrent wages

If you do not pay a bonus at the same time as you pay regular wages and you use the aggregate method, you must take these additional steps:

1. Add the bonus amount to either the wages paid in the last period or the wages to be paid in this period.
2. Calculate income tax withholding based on the total amount, using tax tables, schedules or payroll software.
3. Subtract the tax already withheld or to be withheld from regular wages.
4. If you paid other supplemental wages during the payroll period, add all of the regular and supplemental wages paid during the payroll period, calculate the income tax withholding for the period, and then subtract the tax already withheld from other payments.

Pros and cons of flat vs. aggregate bonus tax withholding methods

The flat percentage method and the aggregate method of bonus tax withholding have pros and cons for employers and employees.

Ease of use

Both tax withholding methods are fairly simple in most cases. The flat percentage rate of 22 percent for most employee bonuses is easy to calculate. Adding the bonus to your employees’ regular pay means you have to look up only one federal tax withholding amount for the combined income, although it will be a higher amount than usual.

If you paid other supplemental wages during the pay period, or if you did not pay regular wages to the employee during the pay period, additional calculations are required. This may create more work for you as the employer.

Accuracy of predicting optimal withholding amount

The goal of tax withholding is to have the withheld amount as accurate as possible so the individual has neither a large refund nor a big tax bill when they file their income tax return.

For employees receiving modest bonuses compared to their paychecks, the aggregate method of tax withholding is probably the most accurate. Their bonuses will generally have tax withheld at their highest income tax bracket, so when they file their income tax returns for the year, they should not have a significantly different tax result than usual.

For employees who receive large, one-time bonus checks, however, the aggregate method may result in too much tax withheld. This happens because the tax withholding tables assume the employee receives the same amount each pay period. An employee in the marginal 22 percent tax bracket could find a portion of the bonus having tax withheld at 32 percent or 35 percent if they receive a significant bonus in one pay period, resulting in too much income tax withheld.

On the other hand, the flat rate percentage method of calculating bonus tax withholding should work well for the many taxpayers whose marginal tax rate is 22 to 24 percent. Employees in the 10 percent or 12 percent marginal tax bracket, however, will have too much tax withheld. Employees in higher brackets who have bonus tax withheld at 22 percent may find they have too little tax withheld.

Have the right amount of tax withheld from your employees’ bonuses

Most employees are excited about receiving bonuses, especially if it’s a once-a-year event they look forward to. However, some of that excitement can be lost if a lot more tax was withheld from their bonuses than they expected. And if you withhold too little, your employees may find themselves unhappy next year, when they file their taxes and owe a large tax bill. 

By choosing the best way to pay and withhold tax on your employee bonuses and making sure your calculations are accurate, you can provide employees with a well-deserved cash boost and rest assured you have done your best to withhold the correct amount of tax.