The IRS considers bonuses a form of wages, and as such, they’re subject to federal taxes, just like your normal pay. However, it’s not just federal tax you have to consider. You might be subject to Medicare and Social Security tax, and unemployment tax. Depending on where you live, you may also have to pay local and state taxes.
The IRS views bonuses as supplemental income, so employers must withhold taxes on bonuses according to IRS regulations. Supplemental income requires a separate withholding calculation in addition to regular wage or salary pay. How these withholdings affect you personally depends on your overall bonus amount, W-4 information, and the method your employer uses to calculate withholdings.
Generally, your employer can choose between two methods of withholding federal tax on your bonus. The IRS gives employers two options: the percentage method and the aggregate method. Below is a closer look at these two methods, along with examples and the pros and cons of each type.
The Percentage Method
The percentage method is a popular method for many employers because it’s the easiest option to calculate. In most cases, when employers disperse bonuses as a separate payment they’re using the percentage method which uses a flat rate system: employers withhold 22% for taxes on the first $1M and an additional 37% on any portion of the bonus over $1M.
For example, let’s say you receive a $3,500 bonus. The employer will withhold 22% of this bonus for federal taxes. This brings your total federal tax withholding on the bonus to $770.
The biggest advantage of the percentage method is that it’s easy to calculate. This is the prime reason so many employers choose this method. It’s also easier for you to determine how much federal tax withholdings will impact your bonus payment.
The big disadvantage is that a flat percentage of withholding may not accurately reflect how these wages get taxed on your return. For example, if your marginal tax rate is higher than 22% (the flat percentage applied for bonuses under $1M), there’s a possibility that your employer won’t have withheld enough taxes, potentially causing a balance due with your return. If, on the other hand, your marginal tax rate is less than 22%, your employer may be withholding more taxes than necessary. In this case, you may have an overpayment, but you’ll have to wait until you file your tax returns to receive a refund.
The Aggregate Method
Unlike with the percentage method, employers don’t disburse separate checks when using the aggregate method. Instead, employers combine regular earnings and bonuses into one single check.
This method results in your employer taxing both your standard earnings and bonus payment at the same rate. Your tax withholding rate is based directly on the information on your W-4 form, such as your filing status and dependent information.
For example, let’s say your filing status is “single.” You earn $2,500 in regular earnings for the biweekly pay period and receive a $1,000 bonus. Your entire earnings for the biweekly period are $3,500, so your federal tax withholdings are based on the entire $3,500. Using the IRS 2025 wage brackets, your federal tax bracket used for withholding would be 22%.
In another example, your filing status is “married filing jointly.” You receive monthly earnings of $5,700, as well as a $2,000 bonus. Your entire taxable earnings for the month are $7,700. Your tax withholdings are based on the entire $7,700. When using the IRS 2025 wage brackets, your federal tax bracket used for withholding would be 22%.
The biggest advantage of the aggregate method is that it typically provides more accurate results. By calculating tax withholdings on your specific W-4 information, there’s a greater chance of using the correct tax rate. However, there’s still a chance that you might owe money or receive a refund at the end of the year.
The disadvantage of the aggregate method is two-fold: 1) it is often more time-consuming for small employers, but larger companies use payroll technology that can handle these calculations automatically; 2) by combining your earnings and bonus in one check, it’s possible for you to get pushed into the next tax bracket, increasing the likelihood of over withholding. Ultimately, this factor could result in your bonus being taxed at a higher rate than necessary!
Can You Reduce the Tax Impact of Bonuses?
Most folks will wonder: “Why are bonuses taxed so high?” The answer is: the IRS considers bonus pay to be supplemental income, and treats it differently than your standard income. The purpose is to help you save some money back on taxes now, so you don’t face a large tax bill at the end of the year.
No matter which tax withholding method your employer uses, receiving a work bonus could have a significant impact on your taxes. It’s important to know what to do with this increase in earnings and to take proactive steps, if possible, to minimize this impact as much as possible before Tax Day. Here’s a look at several options that might help you reduce the tax impact of bonuses.
- Tax deductions: When filing your taxes, you can choose between using the standard deduction or itemizing your deductions, whichever is higher. Many taxpayers use the standard deduction method. While it’s the easiest method to use, it’s not always the most beneficial. Explore your options and determine which deduction method offers the greatest benefit. For example, if you had significant medical expenses, substantial disaster losses, or large charitable donations, itemizing your deductions may be the better option. It’s always recommended to calculate your deductions using both methods to determine which option works for your specific situation. If you’re using an online tax preparation service or working with a professional tax preparer, they’ll likely ask you a series of questions to help you determine which tax deduction method you should use.
- Defer bonus to a new tax year: If you know you’re about to receive a bonus that may push you up into the next tax bracket and want to reduce your current year’s tax liability, you may be able to request that your employer defer your bonus until the following year. By deferring your bonus, you won’t have access to any of the money until the following year. Deferring your bonus to the next year makes the most sense if you think you might move into a lower tax bracket in the following year. For example, if you plan to retire or move to part-time work in the following year, deferring your bonus may make sense, and will give you more time to save money to cover the eventual cost of the bonus.
- Contribute to a tax-advantaged account: Another popular option for mitigating tax liabilities is to contribute to a tax-advantaged account, such as a 401k, traditional IRA, or Health Savings Account (HSA). If you have one of these accounts, consider using a portion of your bonus to make a qualifying contribution. Since these contributions are made on a pre-tax basis, it can help lower your overall tax liability for the year. Plus, you’ll be saving money in a tax-advantaged account. Keep in mind that these accounts have annual contribution limits. Check to make sure you don’t exceed these limits, or you risk facing unwanted tax penalties.
- Review your W-4: One of the first things you can do to minimize the tax implications of a work bonus is to review your W-4. Check to make sure your tax filing status is correct. For example, if you were just recently married but still have your filing status marked as single, you can expect a higher tax withholding if your employer uses the aggregate method. You also want to make sure all additional information, such as deductions, is correct.
Contact Us: Receiving a bonus is exciting and often well-deserved, but it’s easy to get so caught up in the excitement that you forget about the impact tax withholdings might have on the amount. Understating how tax withholdings work and how this might impact your bonus can help you prepare better and enjoy it more! Still have questions? Email CPA@fuoco.com.
