Are you a small business owner considering paying a bonus for yourself or your employees this year?
The Tax Implications For Small Businesses of Paying Bonuses to Owners or Employees
Bonuses are taxed differently as "Supplemental Wages"
A bonus is always a welcome bump in pay, but it’s taxed differently from regular income.
Instead of adding it to your ordinary income and taxing it at your top marginal tax rate, the IRS considers bonuses to be “supplemental wages” and levies a flat 22 percent federal withholding rate, unless your employer pays bonuses alongside regular wages. Then, the tax withholding on your bonus is calculated at your regular income tax rate, which is based on your tax bracket.
When taxed this way, your initial tax withholding is higher. In general, bonuses of any kind, including signing bonuses and severance pay, fit into the supplemental wages category.
What Does the IRS Consider to be "Supplemental Wages"?
Other examples of supplemental wages include:
- Accumulated sick leave
- Certain commissions
- Overtime pay
- Prizes and awards
- Back pay
- Reported tips
- Retroactive pay increase
- Payments for nondeductible moving expenses
- Specific forms of equity compensation (like restricted stock units and exercises of non-qualified stock options)
Employee Achievement Awards - The Exception to the Supplemental Wages Rules
The IRS will expect its cut of any bonus you receive. Even if you receive your bonus in cash, gift cards, a vacation, or other benefits. The exception to this rule is if your bonus can qualify as an employee achievement award.
You might be able to avoid paying federal income taxes under the following conditions:
- The award isn’t cash, a cash equivalent (such as a gift card or money order), tickets to events, vacations, stocks, bonds, or other prohibited items.
- The award is tangible personal property.
- The total value of the award doesn’t exceed $1,600.
- Tax withholdings aren’t the end of the story.
The method used to calculate the federal withholding on your bonus can have a big impact on your take-home pay. Still, you won’t know how much you actually owe the IRS until you file your tax return the following year.
Reducing the Risk of Owing the IRS Money
You can reduce the risk of owing the IRS money by reviewing your W-4 withholdings. The IRS Tax Withholding Estimator is a good place to start. Also, if you receive a large bonus or your financial circumstances change, it may be best to talk to speak with us for advice.
Lowering Your Tax Withholding on a Bonus
Want to lower the amount of taxes withheld from your bonus? Consider paying a bonus separately from a regular paycheck. From there you can see if you should calculate its tax withholding at the 22 percent flat rate the IRS allows for supplemental wages.
More Tax Tips
Want more tax tips like this before year-end? Download our Year-End Tax Planning Guide today.