It is the end of the calendar year and the holiday season which can mean for many employees their employer will be looking to reward a year of hard work with year-end bonuses. Both employees and employers can often be shocked and saddened when they see the net pay amount for a bonus to employees which further perpetuates a common concern and question from both employees and employers: Are Bonuses Taxed Higher than other forms of Compensation?
Bonuses are a form of wages for taxpayers and therefore are treated as ordinary income; as such, they are ultimately taxed the same as any other form of wages – they are NOT taxed higher. However, there is an important factor that can for many employees and employers make them feel as if they are taxed higher which has to do with the how the withholding is calculated for bonuses.
The IRS and state taxing authorities generally allow for two methods of withholding on bonuses: the supplemental method and the concurrent method.
Under the supplemental method, bonuses (along with other forms of supplemental wages) are withheld based on flat-rates. For 2022, this rate is 22% for the IRS and various rates for different states (New York is currently 11.70%); often this rate is “higher” than the rate that employees are accustomed to in their period paychecks.
Under the concurrent method, bonuses are added to the employee’s periodic wages for the period and treated as one single payment and withholding is calculated using the withholding tables or other specified calculation for that period. As these calculations are designed to withhold with the assumption this payment is otherwise being paid every period, it will often withhold at a higher rate (as it presumes a higher bracket) than employees are accustomed to in their period paychecks.
The above both show the crux of this issue: the withholding itself is likely higher than taxpayers are used to, which makes these bonus payments feel like they are taxed higher than regular wages. However, when employees file their returns the following year, any additional or excess withholding on this bonus above the employee’s tax rate is refunded. As a simple example:
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.