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This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma Tax®. It has been updated for the 2020 tax year.
Who doesn’t love a bonus from their employer?
Maybe you got one for the holidays or are expecting one in the first quarter of the new year. Perhaps you’re on track to receive a reward for good performance or meeting a specific business goal throughout the year. Regardless of why or when a bonus shows up in your paycheck, the IRS views that money as income and you’ll need to pay federal income taxes on it. But the bonus tax rate you’ll pay will depend on how your employer treats your bonus.
Let’s look at how bonuses get taxed.
- Do I have to pay tax on my bonus?
- What taxes might I have to pay on a bonus?
- How are bonuses taxed?
- What other taxes might come out of my bonus?
- Can a bonus affect my tax bracket?
Do I have to pay tax on my bonus?
Your bonus check may be a reward for your hard work throughout the year, but Uncle Sam still wants his share. In most cases, you’ll have to pay federal taxes on a bonus. Even if you and your employer view your bonus as outside of your regular compensation, the IRS classifies bonuses as supplemental wages.
Generally, any compensation (including bonuses) you receive from your employer is considered income, whether it’s money, property or services. Unless the law specifically says otherwise, income is taxable.What counts as taxable income?
And it doesn’t matter what form the bonus comes in. Did your employer give you a tidy cash sum for outstanding work? Send you on an all-expenses-paid vacation for meeting a business goal? In either case, you’ll still likely get taxed on the bonus. If your bonus is in the form of goods or services, you’ll have to include the fair market value of them as part of your income. But there is a noteworthy exception: employee achievement awards.
Excluding employee achievement awards
If your employer presents you with an achievement award, you may not have to pay federal tax on it provided …
- The award is tangible, personal property like a watch or pen (other than cash, a gift certificate, or an equivalent item).
- The amount you’re excluding is equal to the employer’s cost.
- The award or awards can’t be more than $1,600 ($400 for awards that aren’t qualified plan awards) for all such awards you received during the year.
- Your employer makes the award as “part of a meaningful presentation” that makes it clear this is an award.
- The length-of-service award is for five or more years of service, and you haven’t received another length-of-service award in the last four years.
- Ten percent or less than 10% of eligible employees received safety achievement awards during the year. Keep in mind that you can’t receive a safety achievement award as a manager, administrator, clerical employee or other professional employee.
What taxes might I have to pay on a bonus?
Unless your bonus meets the criteria to be excluded from your taxable income, you’ll have to pay federal income tax, Social Security, Medicare and unemployment taxes, and any state tax, on the bonus amount.
For 2020, the Social Security tax rate is 12.4% total — 6.2% to be paid by employees and 6.2% by employers — on up to $137,700 of wages. Earnings in excess of that Social Security wage base aren’t subject to Social Security tax.
The Medicare tax rate is 2.9% — 1.45% paid by employees and 1.45% by employers. And you’ll pay that on all of your wages; there’s no wage base limit for Medicare taxes.Learn more about the Social Security wage base
How are bonuses taxed?
Federal income tax withholdings for supplemental wages depend on whether your employer pays your bonus separately from your regular wages, and whether it has withheld taxes from your paycheck throughout the year.
If your bonus is less than $1 million (that’s most of us) or equal to $1 million and your employer rolls your bonus into a regular paycheck without differentiating wages from bonus payments, then your employer must withhold federal income tax as if the total amount was a single regular payment. This means the tax rate you pay on your regular salary will get applied to your bonus.
But if your employer pays your bonus separately from your regular paycheck or specifies the difference between wages and bonus money in a regular paycheck, the rules differ.
- If your employer has withheld income tax from your regular wages throughout the year, it can opt to apply a bonus tax rate of 22% and withhold taxes accordingly.
- Or, your employer can add the bonus to your regular wages, calculate the income tax as if the total is a single payment, and then subtract the tax withheld for the regular wages.
If your employer didn’t withhold tax from your regular wages throughout the year, the IRS says it must use the second method to calculate the tax on your bonus.
The calculation method your employer chooses, along with your tax bracket, determines whether your bonus gets taxed at a higher rate or at a rate lower than the one on your regular salary. Take note that if you’re in a higher tax bracket, having your bonus taxed at 22% might save you money.
What other taxes might come out of my bonus?
In addition to federal income taxes, you may see other taxes withheld from your bonus.
Federal payroll taxes
As we previously mentioned, your bonus will be subject to federal payroll taxes, typically including income, Social Security, Medicare and unemployment taxes. But if your compensation has already exceeded the Social Security wage base for the year by the time you get a bonus, you may not have to pay Social Security tax on the bonus amount.
States generally set their own rules for assessing state-level income taxes. Whether your bonus gets taxed at the state level will depend on multiple factors, including whether the state where you earn the income has a state-level income tax.
For example, if your state uses federal adjusted gross income as the starting point for determining what income it will tax, and doesn’t allow a deduction for supplemental wage amounts, your bonus could be subject to state income tax as well as federal.
Check with your state’s tax body or your payroll administrator to learn whether your bonus might be subject to state-level income taxes.
Which states don’t have income taxes?
Seven states have no income taxes at all: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Two states — New Hampshire and Tennessee — only tax interest and dividend income. The other 41 states and the District of Columbia have state-level income taxes. Learn more about state income taxes.
Can a bonus affect my tax bracket?
The federal income tax rates your income is subject to is directly tied to how much income you have. The U.S. has seven federal income tax rates: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Each rate is tied to a range of income referred to as a tax bracket.
The system is progressive, meaning your income could fall into more than one tax bracket and be subject to more than one rate. “Marginal tax rate” refers to the highest rate that applies to your income.
It is possible for a bonus to bump your income into the next tax bracket — and increase your marginal tax rate. Here’s how it could work.
Let’s say you’re a single filer with total annual earnings of $39,000 in 2020. This puts you near the top of the 12% tax bracket, which covers income from $9,701 to $39,475. Your marginal tax rate is 12%, although your income from $0 to $9,700 is taxed at the lower 10% rate.
Now let’s say your employer pays you a generous 5% bonus during the tax year. That extra $1,950 increases your total income for the year to $40,950. Now your marginal tax rate is 22%. But before you get too worked up, keep in mind that the 22% rate will only apply to the portion of your income over $39,475, which in this case would be $1,475.
Something to keep in mind
The more income you have, the more your tax liability may increase. If you don’t have enough tax withheld throughout the year, you may find yourself owing when tax time arrives and you file your tax return.
One way to help reduce the risk of facing a tax bill when you file is to review your W-4 withholdings. The IRS recommends employees check their withholdings using the service’s online Tax Withholding Estimator to get a better idea of the amount of taxes you should have withheld throughout the year.
It’s great to get a bonus, whether it’s some extra cash around the holidays or a reward for great performance. But it’s important to realize bonuses are generally considered taxable income just like your regular income, and to understand how your employer will withhold applicable taxes on your bonus. Understanding how bonuses are taxed can help you be prepared when filing your income taxes.
Christina Taylor is senior manager of tax operations for Credit Karma Tax®. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.