Taxes on Bonuses? Here’s What You Need to Know
If you are lucky enough to be paid a bonus once a year, you know how great it feels to have some extra money to pay down debt, pay for a vacation, home improvement project or to put into savings for a rainy day. While a work bonus is a great thing in the short term for your wallet, they do raise some tricky tax issues.
Before you go out and spend your entire bonus, you should think carefully about how much you will be taxed on it come April. You may want to put a portion of it away, so that when it comes tax time, you will be ready. Here are some tips on how to be ready:
1. Bonuses are actually considered “supplemental pay” and treated differently than your regular wages by the IRS. Your employer can calculate the taxes taken out in two ways – either using the percentage method or the aggregate method. If your employer opts for the percentage method, they take a fixed, flat percentage of your bonus for taxes. If your employer instead uses the aggregate method, they take several factors into account when determining how much to take out for the IRS. They will consider the tax withholding information you gave them on your W-4 and combine your monthly income with the bonus amount. The aggregate method is more complicated than the percentage method and can also take more of your bonus in taxes.
2. High dollar bonuses: What if your bonus exceeds a million dollars? Not a problem for the majority of Americans, but you might be interested to know that for these high dollar bonuses, more taxes are taken. For any amount over $1 million, the IRS takes 35% in addition to the 25% that they take for the amount up to $1 million.
3. Don’t necessarily blame the IRS: It’s easy to feel like too much of your bonus is going to taxes, but one important point to remember is that this is dependent on the way your employer calculates the tax; the IRS does not make this determination.
4. Reduce other taxes with your bonus: If you spend some or all of your bonus on things that you can deduct, then you can keep a bit more in your pocket this year. For example, you can invest more in your retirement plan, make improvements to your home that benefit the environment, or make a donation to your favorite charity. It is important to note that anything you do to try to save on taxes must be done by the end of the calendar year (December 31st).
Start Planning Now
You may still have some questions about your incoming bonus. If you want more information about how much your employer will take from the total amount, you can always get advice from a reputable tax firm like Success Tax Relief. Our firm can review your income level and your bonus information and help you project exactly how much will go to the IRS and how much will stay in your pocket. Contact us today for help with this and other complex tax issues.