For some lucky workers, December means that year-end bonuses are on the way. This can be considered good news (especially since some companies are cutting budgets, laying off employees, or canceling bonuses). However, people are often surprised when their bonus money is lower than they expected. This situation – in which a large part of your paycheck seems to be missing – is due to the withholding of federal taxes and the so-called income tax.
Although you cannot change the tax withholding of the bonus, it is good to know how to pay the tax so that you know how much money to expect. Additionally, knowing how much pay will be coming into your account can help with year-end tax planning. This could include navigating tax changes for 2022, and trying to offset revenue through tax and tax cuts.
How to pay taxes: Why are bonuses so high?
When you find that the value of your check or direct deposit is less than the bonus amount promised by your employer, it is likely because your employer withheld taxes from your bonus. (However, it is always important to double check your bonus amount as stated by your employer.)
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First of all, bonuses are taxable because they are considered taxable income. But the IRS considers bonuses to be extra pay. In general, overtime pay is a type of pay—for example, overtime, commission, etc.—that is not regular pay. When your employer pays extra wages, they should follow the rules of payroll tax and deduct part of those wages (in this case, your bonus), for tax purposes.
The amount of your bonus depends on the withholding method your employer uses, which depends in part on the amount of your bonus and how the bonus is paid.
Tax Bonus: How Tax Bonus Works
Percentage method: The first method of withholding additional income tax is called the percentage method. This method is often used when your paycheck is issued separately from your regular paycheck.
The percentage method means that if your profit is less than $1 million, your employer automatically keeps 22% of the bonus for tax purposes. (If you earn commissions or have been paid laundry, you may have also withheld 22% because these types of payments are considered overtime.)
So, if you were told that you have a profit of $5,000, and your employer uses the percentage method, they should keep at least 22%, which based on this example is $1,100.
If your bonus is over $1 million, the termination rate is 37% of the bonus amount over $1 million. Thirty-seven percent is associated with the highest federal income tax rate.
Combination method: Another way to keep extra pay is the compounding method. This is usually used when your employer pays the bonus amount along with your regular salary in a single payment. In this method, your employer withholds taxes according to a formula based on the information you provided on your W-4 Form.
How to keep a collection can cause confusion and frustration for people. This is because your regular pay and bonus pay are combined, in total. As a result, the amount of tax withheld from your paycheck is higher than what you would normally pay on your regular payday. Keep in mind that other legitimate income, and wages, taxes (for example, state income tax, social security tax, etc.).
Can you avoid paying tax on your bonus?
Because you must retain your employer, you cannot avoid tax on the bonus. But it can be frustrating to receive compensation for a job well done and then find out that most of the money goes to taxes.
With that said, if you’re wondering how much your bonus payment might affect your taxes, the IRS has a calculator that can help you estimate your withholding before you file your tax return. And, when you file your federal tax return, it turns out that too much tax was taken (based on income and tax rate), you can expect a tax refund.
On the other hand, if you are concerned that your bonus will be large enough to put you in a higher income tax bracket, you may want to consider deferring your bonus to the new tax year. .
For example, if your company plans to pay your bonus now (ie, in December), and you expect to earn less next year, you might want to ask if you can payments are deferred until 2023.
You can also deduct bonuses and other income from your tax return at the end of the year. Taking a tax deduction for charitable donations or contributions to a retirement savings account can sometimes reduce your taxes.
But remember: December 31st is the deadline to make the big tax contribution that could help offset your end-of-year allowance.
