How to Calculate Tax Rate on Bonuses: A Complete Guide to Bonus Taxes

As a business owner, you understand the importance of recognizing and rewarding your employees' hard work and dedication. Offering bonuses can be a powerful tool for increasing motivation and driving performance. However, navigating the tax implications of bonuses can be a daunting task. 

Many people wonder how are bonuses taxed when it comes to additional compensation at work. As your trusted tax experts, the Porte Brown team specializes in complex tax issues, including bonus taxes. 

In this comprehensive guide, we'll walk you through everything you need to know about bonus taxes, ensuring you can make informed decisions while rewarding your team. 

What is a Bonus?

A bonus is an additional form of compensation awarded to employees beyond their regular salary or wages, often given to celebrate achievements and milestones or as part of a structured compensation plan. 

So, are bonuses taxed differently? Are bonuses taxed higher than regular income? Because they are outside your standard pay, the IRS categorizes this income as supplemental wages, subjecting them to specific tax treatment. 

Bonuses count as additional income, which means a higher tax rate applies than standard wages. Bonus income is typically subject to a 22% federal bonus tax rate. Employers must also withhold Medicare and Social Security taxes and may need to account for state bonus taxes. 

Giving a Discretionary Bonus

Employers may award optional bonuses based on exceptional performance, meeting specific goals, or special occasions. For example, a holiday bonus would be considered discretionary. Employers can not utilize discretionary bonuses to fulfill any part of the standard salary threshold. 

Giving a Non-discretionary Bonus

On the other hand, employers grant non-discretionary bonuses according to specific criteria. For instance, an annual performance bonus is a form of non-discretionary reward.

Additionally, contracts like union agreements or employment agreements may require this incentive. It's important to note that these bonuses must be included in the weekly gross pay for overtime calculations, applicable to hourly employees and exempt employees eligible for overtime.

Benefits of Giving Bonuses to Employees

Awarding bonuses to employees can yield numerous benefits for businesses, both financially and culturally. Let's explore some of the critical advantages of providing bonuses to employees.

Business Tax Deductions

Bonuses fall under the ‘payments to employees’ category and are deductible business expenses. However, it's crucial to ensure fairness when distributing bonuses among employees. 

If you give bonuses based on performance evaluations, ensure transparency and consistency. Discriminating against certain groups based on factors such as gender, race, or age is unlawful and can lead to legal consequences. Therefore, it's essential to have a clear and justifiable rationale for any differences in bonus allocations among employees.

Increased Morale and Productivity

When employees feel appreciated and valued, their morale and motivation levels soar, leading to increased productivity. Recent research revealed that employees who receive frequent, modest rewards — whether in monetary compensation, points, or expressions of gratitude — are eight times more engaged than those who receive annual bonuses.

Reduced Employee Turnover

Employee turnover can be costly for businesses regarding recruitment, training, and lost productivity. However, by providing employee bonuses, companies can incentivize loyalty and retention. 

Research indicates that organizations with solid recognition programs have a 31% lower voluntary turnover rate than those with poor recognition cultures. 

Positive Company Culture

A culture of appreciation and recognition can significantly impact employee satisfaction and company culture. When employees feel valued and acknowledged for their contributions, it creates a sense of belonging and pride in their work. 

This positive company culture improves employee morale, attracts top talent, and enhances the organization's reputation. According to a study by Deloitte, 94% of executives and 88% of employees believe a distinct workplace culture is essential to business success.

Are All Bonuses Taxable?

Regarding bonuses, taxation is often at the forefront of employers' and employees' minds. While it's clear that bonuses are generally considered taxable income under Section 61 of the Internal Revenue Code (IRC), there are some nuances to consider. 

For instance, certain fringe benefits, such as tickets to events or gift baskets, may not always be subject to taxation. However, it's essential to understand that not all bonuses fall under this exemption. Achievement awards, which can encompass various forms of compensation like cash, vacations, meals, and even securities, may still be taxable depending on specific circumstances. The frequency and value of the bonus play a significant role in determining whether taxes need to be withheld. 

Choosing Tax Withholdings on Employee Bonuses

So, how are bonuses taxed, exactly? While consulting with a tax professional for personalized advice is recommended, there are general principles to remember. Typically, employers will withhold tax on bonus payments similarly to regular paychecks. When calculating the federal bonus tax rate, employers have two options.

The Percentage Method

As an employer, it's crucial to understand how bonuses are taxed to ensure compliance and accurate withholding for your employees. You have two primary options when calculating the federal tax rate on bonuses. Firstly, the percentage method treats the bonus payment as separate income from regular wages and automatically withholds 22% for taxes. 

How much are bonuses taxed? The answer will depend on the amount awarded. However, it's important to note that for individuals receiving bonus payments exceeding $1 million in a calendar year, a higher withholding rate of 37% applies to the amount exceeding $1 million. 

In comparison, the initial $1 million is taxed at 22%. You must use this method if your employees receive more than $1 million in supplemental income within the calendar year. 

The Aggregate Method

Employers can use the aggregate method to include bonus payments and regular wages in a single paycheck without specifying each amount when reporting to the federal government. Under this method, bonus taxes are withheld on the entire payment as though it's a single paycheck in a regular payroll period. 

This approach is helpful in commission-based jobs, which award supplemental income throughout the year. Understanding and implementing the aggregate method ensures accurate tax withholding and payroll processing for employees in such scenarios.

To navigate tax withholding complexities accurately, employers should refer to official IRS resources like Form 941 instructions and IRS Form W-2 for information. These documents provide essential guidance on reporting bonuses as income and Social Security and Medicare wages, ensuring compliance with tax regulations. 

Simplify Your Business Taxes with Porte Brown

At Porte Brown, we understand the complexities of business taxation and are here to assist employers with any tax-related questions or concerns. With our services and expert guidance, employers can optimize their accounting and tax strategies to ensure smooth operations for their business. Learn more about the industries we serve and check out our valuable resource center online. 

Trust Porte Brown for your outsourced accounting needs, or find a seasoned Chicago accountant. We are your reliable tax partner to help you navigate the intricacies of bonus taxation and beyond. Contact us today to learn more.


How are bonuses paid to employees?

Employers pay bonuses to employees in a variety of ways. They can be applied monthly, quarterly, or yearly on an employee’s paycheck, but that varies depending on the type of incentive. 

When are bonus taxes withheld?

The employer typically deducts from an employee’s paycheck. This standard practice ensures that the employee's tax obligations related to bonuses are met promptly. 

However, it's essential to note that if the amount withheld falls short of covering the individual's total tax liability for the bonus, they may find themselves owing taxes when filing their tax return. Therefore, employees should carefully review their tax withholding statements to ensure accuracy and address potential discrepancies.

Do employees have to be taxed on bonuses?

Yes, employees are subject to taxation on bonuses as they are considered taxable income. There's no legal means to provide bonuses to employees without imposing taxes on them. When unpacking why bonuses are taxed higher than regular income, the key lies in the additional income to an individual’s salary or wages.

Employers have two options for managing the taxation and processing of bonus payments. They can either run a separate bonus payroll, known as “the percentage method," or include the bonus in the regular payroll run and designate it accordingly, termed "the aggregate method." Each method has implications, and employers should carefully consider which approach best aligns with their business practices and tax obligations.

Can employees lower their taxes on bonuses?

There are numerous strategies employees can take to mitigate the tax burden on their bonuses. One primary method for reducing tax liability is by lowering taxable income. Employees can accomplish this by leveraging tax-advantaged retirement accounts such as a 401(k) or an IRA. By allocating a portion of their bonus funds towards these accounts, employees save for retirement and benefit from immediate tax savings. 

Employees may also consider other tax-efficient investment options or charitable contributions to optimize their tax situation further.

Can business owners give themselves bonuses?

Any compensation the business owner receives will be subject to personal income tax based on their regular tax rates. That means the bonus amount and any other income earned will be reported on the individual's income tax return and taxed accordingly. However, it's essential to note that the business can take advantage of certain tax benefits regarding compensation to its officers or employees. 

The IRS allows businesses to deduct payments made to officers, employees, and other staff members as legitimate business expenses. Therefore, while the business owner will be personally taxed on the bonus received, the business can claim a deduction for this payment, helping mitigate its overall tax liability.

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