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    Bonuses and Taxes

    By Teri Newton

    You’ve probably wondered why your bonuses are so heavily taxed. It’s all in the tax law. There are two methods to determine bonus withholding. One method is called the Percentage Method; the other is the Aggregate Method. Which method is used to tax your bonus is determined at the state level.

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    The Percentage Method is not very favorable to the average taxpayer. A flat tax of 25% at the federal level, and a flat state percentage (I know it happens to be 9.3% in California), will be withheld from your bonus. It doesn’t matter if you are in a low tax bracket or if you usually get to keep 90% of your check. This is a flat tax, regardless of your tax bracket. Your only recourse in this situation is if you have a guaranteed bonus coming your way, you can increase your withholding allowances during the year. This means your regular paychecks will have less income tax withheld, to offset the high tax withholding on your bonus. Another alternative is to wait until you get your bonus, and then increase your withholding allowances, so that less tax is withheld the rest of the year. These are difficult strategies to implement though, since most bonuses come at year-end, and you do not want to risk under-withholding for a bonus that might never appear.

    The Aggregate Method can be a little bit better for your bottom line. In many states, the aggregate method is allowed, which means the tax withheld on your bonus check is based on your wages and tax withholding to-date. This basically means it will be calculated like any regular paycheck. Regardless, this method will still take a big bite out of your bonus. The reason is that often payroll software does not recognize that a bonus is a one-time payment. So the payroll software might assume that your $1,000 bonus check is really a recurring amount that will push up your annual income much higher. For the one bonus, it may assume it needs to withhold a lot more, because the software suddenly thinks you are in a much higher tax bracket and that you need to be taxed at a higher rate. For smaller bonuses, many employers don’t even realize there is a "method" so faulty software calculation is probably the biggest bonus problem for most of us.

    Even if your employer figures out your bonus correctly, the fact is, a bonus is usually a large amount compared to your regular paycheck. Let’s face it; a bigger check is going to need more taxes withheld. The taxes are simply magnified. All of these factors lead to you getting a smaller bonus check than you expected.

    But there is another problem when it comes to bonuses. If you are in a high tax bracket, and your company uses the percentage method, you may find that you are under-withheld at the end of the year. Maybe your federal tax rate is 35%, but your company only withheld 25%. In this case, if you are concerned about under-withholding, simply ask your employer to withhold more taxes from your bonus checks. Your employer can honor your request to withhold more. They just can’t honor a request to withhold less on a bonus.

    If you are expecting a bonus and want to figure out how much you can expect to keep, check out the bonus calculators at <a href="http://www.paycheckcity.com" rel="nofollow">paycheckcity.com</a> . This is a great tool to help you get a handle on your paychecks. You can see how claiming different numbers of allowances and how varying scenarios will affect your withholding. The website has both regular paycheck calculators and bonus calculators. Make sure to select your state to get accurate results from these calculators.

    #2
    So if I have 30K regular earning +1k bonus, the tax will be the same as if I earned 31K? So when I do my tax return, it doesn't matter what money came from bonus, and what from regular pay, they all added together and taxed in the same bracket?

    Comment


      #3
      Originally posted by getforfree View Post
      So if I have 30K regular earning +1k bonus, the tax will be the same as if I earned 31K? So when I do my tax return, it doesn't matter what money came from bonus, and what from regular pay, they all added together and taxed in the same bracket?

      I am sorry I just saw this, but yes.

      But it doesn't mean the IRS doesn't have different withholding rules on different types of income. Just as some states do.

      Comment


        #4
        Can someone help me? A huge portion of my pay is tied up in monthly bonus checks. I receive a bonus check between 2-10 grand every month. It looks like they tax it at 35%. So far this year, i've paid over $22,000 in taxes, and have only taken home about 50% of my total earnings. IS there a way that i can hold onto more of my money? or am i goign to get a huge refund? does anyone have any resources for me....

        Comment


          #5
          Maybe you can increase your allowances on your w2 form to pay less tax from your regular earning.

          Comment


            #6
            Yes - if you are sure too much is witthheld, all you can do is change your W-4 to claim more allowances.

            Comment


              #7
              Originally posted by munionj View Post
              Can someone help me? A huge portion of my pay is tied up in monthly bonus checks. I receive a bonus check between 2-10 grand every month. It looks like they tax it at 35%. So far this year, i've paid over $22,000 in taxes, and have only taken home about 50% of my total earnings. IS there a way that i can hold onto more of my money? or am i goign to get a huge refund? does anyone have any resources for me....
              You can increase your W-4 allowances, and you won't pay as much on your regular income in the future. You will also most likely get a huge refund for this year's taxes (figured in 2008).

              Comment


                #8
                Does it mean that I will get some it back on my tax return for sure? let say if I pay 18000 of taxes out of a $50000 bonus check?

                Comment


                  #9
                  bonus check

                  Originally posted by babeth View Post
                  Does it mean that I will get some it back on my tax return for sure? let say if I pay 18000 of taxes out of a $50000 bonus check?
                  Does it mean that I will get some it back on my tax return for sure? let say if I pay 18000 of taxes out of a $50000 bonus check?
                  How about if I put in saving account like Pacific funds?

                  Comment


                    #10
                    Ahh, this explains so much. My bonuses are treated like a paycheck and so I still get most of it since they take out the normal tax rate but my husband works for a Fortune 500 company and he loses more than 50% of his bonus to taxes. Always wondered why we had different tax rates for our bonuses.

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                      #11
                      regardless of what gets witheld, it is taxed as ordinary income on the tax return you file. The issue is whether government gets a free loan until April 15, or if you get a free loan until April 15.

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                        #12
                        Exactly. It really comes down to whether you want to give the IRS a free loan or not. Make sure though to pay your taxes, because the IRS collection process is tough.

                        Manny Davis Jr. CPA

                        Comment


                          #13
                          It sounds like it would be more cost effective to spread a bonus out in multiple regular paychecks.

                          Comment


                            #14
                            Originally posted by munionj View Post
                            Can someone help me? A huge portion of my pay is tied up in monthly bonus checks. I receive a bonus check between 2-10 grand every month. It looks like they tax it at 35%. So far this year, i've paid over $22,000 in taxes, and have only taken home about 50% of my total earnings. IS there a way that i can hold onto more of my money? or am i goign to get a huge refund? does anyone have any resources for me....
                            I'd recommend going to a CPA for assistance. Sounds like they could help.

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