American workers who received bonuses last year may have noticed higher tax withholdings compared to their regular paychecks. This difference is not a perception issue but stems from specific IRS regulations that treat bonus payments as supplemental wages.
The Internal Revenue Service defines supplemental wages as payments beyond regular compensation, including bonuses, commissions, overtime pay, severance pay, awards, and certain other benefits. According to IRS Publication 15, these payments are generally subject to income tax withholding unless specifically excluded by law.
Company parties, employee discounts, occasional meals, and nominal non-cash gifts typically fall outside taxable bonus categories. However, most cash bonuses and cash equivalents must be reported as taxable income on federal tax returns.
Employers use two primary methods to calculate tax withholdings on bonuses. The percentage method applies a flat 22% federal withholding rate on bonuses up to $1 million, with amounts exceeding that threshold taxed at 37%. This method often results in over-withholding for workers in lower tax brackets, potentially leading to tax refunds during filing season.
Under the aggregate method, employers combine bonus payments with regular wages for a pay period and apply standard withholding rates. This approach can result in different take-home amounts depending on the employee's tax bracket, with higher earners seeing more withholding and lower earners retaining more upfront.
Workers receiving substantial bonuses have several options to manage tax implications. Adjusting W-4 withholdings in advance can help prevent bracket jumps. Reducing taxable income through charitable donations, tax credits, and deductions is another strategy mentioned by financial advisors.
Contributing bonus money to tax-advantaged accounts like 401(k)s, IRAs, or Health Savings Accounts can offset tax burdens within annual contribution limits. Some workers may also consider deferring bonus payments to future tax years when overall income might be lower, though this carries employment stability risks.
State tax authorities also treat bonuses as supplemental income, with many applying additional flat rates between 5% and 7% depending on location and adjusted gross income. Employers are required to withhold both federal and applicable state taxes from bonus payments.