How are bonuses taxed?

[bank5]

I was talking to a friend today who was talking about tax strategies for bonuses. I know that bonuses are originally heavily taxed but I figured it's added on to your AGI and things even out when you file your taxes. For example if you make $30k and with a $5k bonus you'll get taxed the same as making $35k.

However, my friend, said that a bonus actually shows up in a separate location on your W-2 and it is taxed differently from ordinary income. Is this the case and if so what are some tax strategies for receiving bonuses?

 

[Alan]

I've received bonuses for many years, paid in cash (ie not shares or stock options), and reported as a separate line item on my W-2. In my case the bonus is not counted as earnings on which my pension is based or on which 401(k) contributions are taken or matched.

However they have always been taxed exactly the same as the rest of the earned income, so I know of any tax strategy to minimize tax reductions on bonuses paid as cash.

 

[W2R]

It may be different for someone in high finance than it has been for me, a lowly government worker. I have received a number of merit-based cash awards which were no different from my salary as far as taxes went. As was the case for Alan, they didn't count as far as pension, SS, or 401K contributions so it they weren't in the W-2 block pertaining to SS.

Are you getting a bonus? If so, congratulations!

 

[ziggy29]

If bonuses are paid as regular cold, hard cash they are taxed as ordinary income (after any deductible taxes and pension/401K contributions). If you get it in the form of stock options, other rules apply.

 

[W2R]

If bonuses are paid as regular cold, hard cash they are taxed as ordinary income (after any deductible taxes and pension/401K contributions). If you get it in the form of stock options, other rules apply.

That's probably what Bank5's friend was talking about. I wouldn't know a stock option if it hit me in the face, and it makes sense that they might be taxed differently.

 

[bank5]

Thanks all for the responses. I was referring to cash bonuses and it's good to know they're taxed like ordinary income.

Are you getting a bonus? If so, congratulations!

I haven't received a bonus in years...actually the largest bonus I ever received was a signing bonus for an internship It was a really sweet bonus though especially for a poor college student so I can't complain. My wife's company gives generous bonuses...although I'm sure they'll be a bit lower this year.

 

[FIREd]

DW's bonuses, when paid in cash or stocks, are lumped with her regular income on her W-2 and are taxed as ordinary income.

 

[youbet]

DW's bonuses, when paid in cash or stocks, are lumped with her regular income on her W-2 and are taxed as ordinary income.

Yep. Bonuses are not only taxed as ordinary income...... They are ordinary income.

 

[Gone4Good]

Yes, most compensation, whether received in cash or stocks or widgets is taxed as ordinary income. Some folks receive "deferred" compensation, restricted stock, or options with specific vesting periods. Deferred compensation becomes taxable as ordinary income once it vests.

 

[jazz4cash]

Not exactly what OP was referring to, but i know folks that adjust thier W4 for the pay period in which the bonus is paid to reduce overwitholding. An individual could also increase thier 401k contribution if they are not maxed out already. When I have received bonuses, although not eligible for matching, they are eligible for 401k contribution or included in SS earned income calculation.

 

[aaronc879]

We get small quarterly profit sharing bonuses usually between 1%-5% of our pay for that quarter. The IRS consideres it a gift and taxes it at 40-something%. However, it gets mixed in with our regular pay and we get the extra tax back at tax time.

The only tax stragtegy that I know of is "claiming 8". A co-worker said he "claims 8" on his w-4 twice a year. This allows him to basically get an advance on his tax return. I've never tried it so don't know all the details.

 

[Maurice]

Yep. Bonuses are not only taxed as ordinary income...... They are ordinary income.

Yep.

 

[SecondCor521]

A former employer of mine, a Fortune 100 company, used to pay semi-annual profit sharing and they withheld taxes at the highest marginal income tax rates from that bonus check regardless of your W-4 settings.

It was explained to me that the company did it that way to ensure employees were not underwithheld due to a large bonus.

2Cor521

 

[Maurice]

I think he was asking how they were taxed, not about withholding.

(FWIW, my employer, a top-tier investment bank, withholds cash bonuses at 25%, regardless of the amount.)

 

[youbet]

I think he was asking how they were taxed, not about withholding.

Agreed. There seems to be some confusion between withholding rates vs the actual tax on the bonus determined when filing your taxes. That can only be known by completing your tax forms and doing a what -if analysis by comparing your total tax with and without the bonus.

At least that's now it seems to me......

 

[Alan]

When I worked in the UK I used to get stock as a bonus and how it worked was that the company would calculate the average share price for the year Jan thru Dec then in the following January we would get the bonus (say 5% of annual salary if the company had had a good year) paid in shares bought at the declared average price. The 5% bonus would be taxed as normal income. If/when you chose to sell the shares they would then be subject to capital gains tax only (assuming you sold at a higher price).

 

[shigsy]

When I reported bonuses for my employees to our payroll company, I would tell them for what period of time they covered (bi-weekly, monthly, quarterly, etc.) which would affect how they would be taxed (the shorter the time period, the more taxes withheld generally, since a shorter period meant a larger amount of annual income if the bonus was multiplied out by the number of those periods in a year). Since bonuses were generally much larger than their normal pay for a bi-weekly period, I would usually categorize them as quarterly payments.

 

[Maurice]

Shigsy, the frequency of payment wouldn't effect how they were taxed. I think like the OP you're conflating taxation with withholding.

 

[growing_older]

At my MegaCorp, when I have received an annual bonus, I have noticed that the rate of withholding is higher than it is for my regular income. In the end when tax returns are filed it's all the same and evens out, but in the tax withholding tables for the paycheck in which the bonus was paid, there's no special provision for a bonus. As a result, when accounting looks up how much to withhold for monthly check of $X, in the bonus month when $X is bigger than normal, they get a larger withholding. The withholding tables are assuming $X is regular monthly income that will continue throughout the year, not that it is a one time event, so withholding is bumped up to a higher marginal rate.

 

[shigsy]

Shigsy, the frequency of payment wouldn't effect how they were taxed. I think like the OP you're conflating taxation with withholding.

It's not the frequency of the payment, but the period that the payment is supposed to represent.

Consider a gross paycheck of $1,000. If the employer reports this as payment for a one week period, the tax withholding would be estimated at a rate of $52,000 annually (52 weeks X $1,000).

Now consider that same paycheck of $1,000 reported as payment for a one quarter period, the tax withholding would be estimated at a rate of $4,000 annually (4 quarters X $1,000).

The difference in tax withholding would be substantial due to the progressive nature of the tax system.

Sorry if my first post was poorly worded.

 

[LOL!]

I always ask that a year-end bonus be delayed until January of the next year and I contribute all (possible) of it to my 401(k).

 

[Texas Proud]

I have not seen any mention of an option... if the company has it...

My old company allowed the higher ups to defer some or all of their bonus to a later year... they had to make the option prior to it being awarded and it was binding on them... but the money (if deferred) was now an ordinary liability of the corp.. and you would get it when you retired.. and pay taxes then...

Otherwise, like others say... get it now, pay taxes now as ordinary income.. BTW, it was not in another box on the W-2...

 

[Finance Dave]

I think the perception that bonuses are taxed higher is because on the paycheck they appear, they are taxed at that time as if you made that amount every pay period...so if it moves you up to a higher incremental bracket you'd see it taxed more heavily on the paycheck...but it is true that IN THE END it's taxed as ordinary income.

My explanation may not be clear, so let me try it this way. Let's say your "normal" check is $5,000 a month, and you pay $1,000 taxes...or 20%. Now let's say you get a bonus check for $50,000 all at once. The taxes would be more than $10,000 (20%) ON THE PAYCHECK, but at the end of the year your tax rate would end up being close to 20% (maybe not exactly 20% if the bonus put you in the next higher bracket).