How is my Bonus Taxed? - Molen & Associates

Stay Ahead of Law Changes & Protect Yourself Against Being Audited: Corporate Transparency Act and Reasonable Compensation

How is my Bonus Taxed?

Are you bringing in a bonus this year? Fantastic! You should be proud of your hard work. I teach my three kids the same fundamental principle every week. Hard work pays off. It’s completely ingrained in them now. From anywhere in the house if I yell out “Hard work!” I get a sometimes emphatic, sometimes pithy response from at least one of them: “Pays off!”

This mentality is an important part of my children’s upbringing. I want them to know they’re in control of their own destiny. Speaking of being in control, let’s talk about governmental oversight and compliance regarding your bonus.

Taxing My Bonus, What Gives?

Okay, I’m going to go full-on fundamental for a moment or two, so please forgive me. Let me make a few crucially important points that we need to be on the same page about, or the rest of this won’t make any sense.

  1. Bonuses are not ultimately “taxed” at a special rate.
  2. You should never turn down a bonus because you’re afraid of being in a higher tax bracket.
  3. Federal income tax withholding is a process in which you make your tax payments throughout the year, rather than all at once come tax time.

Income tax specifics can be incredibly complex. For our purposes I’m going to break it down in a general way, which may not reflect your specific circumstances. If you need specific advice to a specific situation, please consult with a tax expert.

Bonuses are not ultimately “taxed” at a special rate

You don’t pay higher income tax on a bonus than you do your other wage earnings. However, the government does require that a minimum federal income tax withholding rate be applied to bonus earnings. The two can be confused very easily, so I’ll try to clarify.

Bonus: $4,000

Federal income tax withholding minimum rate: 22%

Actual federal income tax withheld: $880

Possible tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, 37%

So far, it does appear that your bonus has been taxed at a specific rate. However, this is not the case. Your withholding rate is a specific, governmentally regulated rate, but upon filing your individual income tax return you’ll determine what tax bracket you’re actually in. This is where the actual tax happens.

This fundamental piece of information is lost on most people. Just because the government requires your employer to take out a certain amount of tax from your bonus, doesn’t mean you pay that tax to the IRS, and it’s gone forever. You see, if you file your personal return, after having withheld tax at a 22% rate, and you’re in a 32% tax bracket, you’ve actually paid too little ahead of time and may owe more. If you’re in a 12% tax bracket, you’ve overpaid and are likely due a refund, depending on other factors.

You should never turn down a bonus because you’re afraid of being in a higher tax bracket

This one drives me up the wall. Tax brackets don’t work the way most people think they work. Want the secret sauce? Check out my 4 minute video describing exactly how tax brackets work:

https://www.youtube.com/watch?v=teGrGCWpEMQ&ab_channel=MolenTax

The video really ought the make this clear, but in case you’re still not 100% on it, earning more income is always better, even if you pay a slightly higher tax on the amount you earned into that higher tax bracket. You’ll never pay more in tax than what you earned. Take the bonus!

Federal income tax withholding is a process in which you make your tax payments throughout the year, rather than all at once come tax time

The federal government is run on our tax dollars. The IRS generates more than 90% of our government’s revenue each year. In order to operate, the system requires that we make payments of tax on wage income as we receive it. Not all income is wage income. Many investments and income relating to businesses have no tax withholding requirements.

Imagine for a moment that every single working person were to go to their payroll department and request a special exemption electing to not withhold any taxes on their paycheck. While this is not typical, you generally have the right to elect this for up to one year. If you owe taxes because of this, you generally cannot make this election again. However, just shoot the breeze with me for a minute here. Imagine every working person did this. All of our tax dollars would cease going to the federal government and in short order the government would temporarily shut down.

I explain this not to start a movement or to spite the government, rather to illustrate a point. The government needs your tax dollars to fulfill its obligations. The amount you withhold in taxes is done not because you’re being “taxed” as you earn income. Instead, it’s a preparatory withholding of tax you will owe on Tax Day, usually April 15th of the following year.

So, How is My Bonus Taxed?

To the point then. Your bonus is taxed at your tax rate, nothing more, nothing less. They may withhold a higher, or lower amount, but ultimately your bonus is just regular income. This principle actually jives a lot with overtime as well, since the information is quite similar.

I get that may seem like a trivial or sarcastic answer, but you wouldn’t believe how much confusion there is on this basic point. Hopefully, with all the fundamental information I’ve laid out, this makes a bit more sense.

Essentially, to better understand exactly how your bonus is taxed, you need to understand how you’re taxed in general. To get a better understanding of that, check out my long-form breakdown of how tax brackets work HERE.

Don’t Do This One Thing, or You’ll Regret It!

It turns out you can actually be too clever. Regarding bonuses, I see this most when someone who kind of understands it, but not fully, decides to game the system and claim exempt on their withholding status for the check they receive their bonus. This way they receive their entire bonus! What’s not to love?

Tax time won’t be showing you love if you do this. These regulations are generally in place for a good reason and if you under withhold on a bonus, you could easily end up owing on your next tax filing.

Finally, I would recommend you always consult with a tax expert regarding your specific circumstances. I will often counsel people I work with to go against the grain on some of these things based on their very specific situations. There is no one-size-fits-all approach to tax planning.

Wait, tax planning? The folks who are clever, but not too clever, are doing this. When was your last tax planning session? Schedule one now by contacting us today! Reference this post and I’ll give you a free 15-minute phone consultation on the spot!

Kevin Molen, EA
Advisory Services Manager

The Molen & Associates Difference

Mike Forsyth

“Super helpful and timely. This is our first year with them and we look forward to trusting them with our taxes and business books for years to come.”

Caitlin Daulong

“Molen & Associates is amazing! They run an incredibly streamlined process, which makes filing taxes a breeze. So impressed with their attention to detail, organization, and swift execution every year. Cannot recommend them enough!”

Sy Sahrai

“I’ve been with Mr. Molen’s company for few years and I felt treated like family respect and dignity. They are caring, professional and honest, which hard to find these days. Love working with them.”

Unlocking the Benefits of Charitable Contributions: A Guide to Maximizing Your Tax Advantages

Unlocking the Benefits of Charitable Contributions: A Guide to Maximizing Your Tax Advantages In the realm of personal finance and tax planning, charitable contributions emerge as a powerful tool not only for supporting causes close to your heart but also for...

Detailed Guide on Cryptocurrency Taxation and Reporting

Detailed Guide on Cryptocurrency Taxation and Reporting  In the United States, the Internal Revenue Service (IRS) has clear guidelines on the taxation of cryptocurrency, which is considered property for tax purposes. This classification has significant implications...

Gig Economy Taxation: a Detailed Overview

Gig Economy Taxation: a Detailed Overview Reporting Income as a Gig Worker Gig economy workers must report all income earned from their endeavors. This includes, but is not limited to: Earnings from part-time, temporary, or side gigs. Income not reported on...

Standard Deduction vs. Itemizing: A Comprehensive Guide for Small Business Owners and Self-Employed Individuals

Standard Deduction vs. Itemizing: A Comprehensive Guide for Small Business Owners and Self-Employed Individuals   As tax season approaches, one of the most significant decisions you’ll face as a small business owner or self-employed individual is whether to take...

Real Estate and Taxes: A Comprehensive Guide

Real Estate and Taxes: A Comprehensive Guide Real estate taxation is a multifaceted topic that encompasses various forms of taxes, including income tax, property tax, and sometimes even sales tax. Whether you’re dealing with personal or business real estate,...

Steps to Filing a Tax Extension

Is Filing an Extension Bad?   We get this question probably a thousand times a year. An extension is not inherently bad, it is truly personal preference. An extension will not increase your risk for an audit or red flag your return with the IRS. In fact, it is...

How to Pay Your Child From Your Business

How To Pay Your Children From Your Business Paying your children through your business can be a strategic way to manage your business's taxable income, while also providing your children with income and potentially teaching them about the value of work.  While it is a...

Tax Tips for Newlyweds

Tax & Financial Tips for Newlyweds in Houston Marriage is a significant milestone that not only unites two individuals in partnership, but in most cases, also merges their financial and tax situations. For newlyweds in Houston, understanding the tax implications...

Self-Employment Taxes: A Deeper Dive

Self-Employment Taxes: A Deeper Dive Self-employment taxes are a critical component of the tax system in the United States, impacting individuals who work for themselves. Understanding the nuances of these taxes can help self-employed individuals plan and manage their...

Education Tax Benefits: Maximizing Savings with Credits and Deductions

Education Tax Benefits: Maximizing Savings with Credits and Deductions Navigating the complexities of tax season can be daunting, but for those bearing the costs of higher education, there are valuable tax benefits that can ease the financial burden. Among these are...

Request an Appointment Today

5 + 12 =

Call us at

Pin It on Pinterest

Share This