The Bonus Tax Rate for 2021 and 2022
Everyone enjoys receiving praise for their efforts, and receiving a bonus can be an especially rewarding form of recognition. Unfortunately, some of that money will be sought after by the Internal Revenue Service (IRS). The amount of tax withheld from your bonus will probably be slightly reduced when you receive it. The good news is that you might be able to recoup some of that money when you file your taxes for tax years 2021 and 2022. It's the same as making excessive deductions from your paychecks over the course of the year. If there is an excess, the IRS will give you a refund.Main Points
- If bonuses are not included in your regular pay, they are regarded as supplemental wages and are subject to their tax-withholding policies.
- Your employer has a choice between two withholding strategies.
- On bonuses under $1 million, the percentage method is a flat 22 percent.
- The aggregate method is a mathematical formula that accounts for your regular income. This might be the most advantageous choice for you if your marginal tax rate is under 22%.
Bonuses Are Additional Pay
Along with severance pay, taxable fringe benefits, vacation pay, back pay, and overtime, the IRS classifies bonuses as "supplemental wages." Anything that is not included in your regular pay is considered supplemental pay. Its withholding policies govern it. How your employer pays you affects these regulations to some extent. Although bonuses may have their withholding regulations, when it comes time to file your tax return, they are treated the same as the rest of your ordinary income. They are a part of your taxable income, which is the amount you owe after all allowed deductions and credits have been considered. Your income determines your tax brackets and the rates that apply to each.What Taxes Apply to Bonuses?
The percentage method or the aggregate method are the two options available to your employer when determining how much to withhold. For 2021 and 2022, a flat 22 percent will be used as the percentage. No other ratio may be used. Note: The federal income tax calculation is done using these two techniques. You must pay Social Security, Medicare, and FUTA taxes in addition to your bonus and other supplemental wages.The Ratio Approach
Simply put, your employer can deduct the flat rate of 22 percent from all supplemental wages under $1 million. After 2017, this rate was implemented. Since it's anticipated to remain in force until the end of 2025, it applies to any bonuses you might receive in the tax years 2021 and 2022. This choice is referred to as the "percentage method" by the IRS. If you were to receive a $3,000 bonus at this rate, $660 would be withheld. Even if your regular wages are taxed at a rate higher or lower than 22 percent, it still applies to your bonus income.Using Aggregates
It's harder to choose this alternative. The information you gave your employer on your Form W-4 and the IRS withholding tables are used to determine the amount of withholding based on the aggregate method on your regular pay as well as your bonus pay. Note that only federal income tax calculations can be made using the aggregate or percentage methods. Bonuses are subject to the same Social Security and Medicare withholding rates as regular income and any state or local income taxes that may be owed. Just your regular income is used to determine the same withholding rate. The amount of withholding on the total combined amount of regular income and bonus is then reduced by this amount. Your bonus is then deducted as a result. Let's assume that you receive $1,000 in regular pay, and $50 has been withheld from it. Then, all in one paycheck, your employer gives you a $3,000 bonus. It transpires as follows: The total combined wage and bonus income of $4,000 is now subject to a $300 withholding. The remaining $250 would be withheld from your $3,000 bonus by your employer after deducting your regular withholding of $50 from that $300.Large Bonuses and Tax Treatment
Let's now assume that your employer is so impressed with you that it chooses to award you a $1.5 million bonus. The 22 percent withholding rate, which is applicable to bonuses and supplemental wages paid in the 2021 or 2022 tax year, is applied to the first $1 million. Your bonus suddenly drops to $1.28 million as $220,000 is immediately paid to the IRS. The $500,000 you received in excess of $1 million is subject to withholding at the maximum tax rate in effect for that year, which is 2021 or 2022, is 37 percent. Another $185,000 of that money goes to the IRS. On that $1.5 million, you will have withheld a total of $405,000: $220,000 at a rate of 22 percent, plus $185,000 at a rate of 37 percent, leaving you with $1,095,000.Do These Tax Regulations Have Any Exceptions?
These procedures are not applicable if you receive your bonus along with your regular pay in a single check and if your employer does not expressly state that the bonus amount is distinct from your regular compensation. The combined amount (your bonus plus regular pay) is subject to withholding in the same manner as if it were all of your regular pay. Otherwise, your employer must compute withholding using either the aggregate or percentage methods.Different Incentive Payments
Different rules govern incentive payments because they aren't regarded as regular income that must be reported on Form W-2. They are not included on Form W-2 with other wages and payments from which taxes are withheld; they are reported in Box 3 as "other income" on the 1099-MISC form. In the auto industry, these payments are most frequently made when the automaker, not the dealership, presents a cash prize to a salesperson. Although incentive payments are included in your taxable income when preparing your tax return, income tax is not withheld from them. However, incentive payments are exempt from Social Security and Medicare taxes.What Is the Best Tax Withholding Method for Bonuses?
The percentage approach is, in general, much simpler for your employer. You might be able to decide which is best for you based on your tax bracket. If you're in a tax bracket that is higher than 22 percent, such as the 24 percent or 32 percent bracket, the amount of withholding on your bonus will be higher when calculated using the aggregate method. If you fall within the 22 percent percentile, it's a wash. Moreover, what if you fall within the 12 percentile? To use the aggregate method, request it from your employer.What if Your Bonus Has Too Much Tax Withheld From It?
Let's say you file your taxes and discover that the amount withheld from your bonus was significantly excessive given your taxable income at the end of the year. If it turns out that the 22 percent rate was excessive given your total income at the end of the year, the IRS will give you a refund for the money deducted from your bonus. Just as it would if you overpaid through withholding from your regular wages, your Form 1040 tax return would reflect an overpayment of taxes. Any discrepancy between the total you paid over the course of the year and the amount your tax return shows you owe will be refunded by the IRS.Most Commonly Asked Questions (FAQs)
Can you avoid paying taxes on a bonus?
You can lower your tax obligation by allocating a bonus to deductible costs or other tax-sheltered uses. These consist of giving to charity, making 401(k) or traditional IRA contributions, contributing to health savings accounts, and paying for specific medical costs. If your regular tax rate is less than 22%, request that your employer add the bonus to your regular pay rather than giving it to you separately.How should a bonus be reported on a tax return?
On the W-2 form you receive from your employer, your bonus will be listed alongside your regular wages. When filing your taxes, you should enter this as wages on line 1 of Form 1040.