Why Are Bonuses So Heavily Taxed?

paycheck bonus tax

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.

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 recours

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34 Responses to Why Are Bonuses So Heavily Taxed?

  1. ~Dawn says:

    Last bonus:
    42% taken out!!

    If we are given gift cards, our paychecks are taxed at the 40-odd % of the cost of the card.

    It bites!!

  2. Tom says:

    Timely topic as our bonuses were distributed yesterday.

    Total state and federal taxes taken out? Zero!

    In this particular case, I simply asked HR/Payroll what I needed to do to minimize the taxes taken out. They told me I could have them reduced to zero on request, but just for the bonus check. Yes, it means I owe more next tax-time, but that is what I’m trying to accomplish. I still have a great deal of time left this year to adjust my withholdings to insure I do not have any penalties, but I tend to do that in October anyway. All in all, March looks to be a good month!

  3. Teri Newton says:

    When you factor is social security (see another of my recent articles) – 40% sounds about right. IT would be 45% in Cali with the higher state tax rate.

    I should have mentioned in the article that though this is the law, but you can ALWAYS ask your employer to lower the withholding. Though technically they shouldn’t, sometimes they will. Good point Tom. It never hurts to ask.

  4. ~dawn says:

    Tom said:
    “Total state and federal taxes taken out? Zero!”

    I would not think that this is a good idea. When I got laid off from one job, I got a 3 months severance and they didn’t take out taxes at all! – I had a tax bill of around 3k.

  5. Richard Kelley says:

    Your article has confused a CPA in
    Florida. She does not realize when
    a tax return is filed the bonus and
    regular pay winds up being taxed at
    same rate, is handled differenty
    for withholding purposes

  6. Lou says:

    I understand the FEDS take 25% off the top. My question is, why does the goverment have a higher rate for bonuses than for regular payroll wages? At some point, some lawmaker(s) proposed this into tax law and it passed. But what was the lawmakers reasoning or justification for this law?

  7. Will says:

    I just had a question if anyone knows. i recently quit a job but when comparing check stubs i noticed the bonus section had a huge difference that means they taxed me but kept the check am i entitled to this check ?? thanks to anyone who can help or direct me to the right answer

  8. kevin says:

    Don’t know the full details, but would guess that you didn’t get the bonus because you left before it was distributed and taxes were taken out in anticipation of this. In this case, you wouldn’t be entitled to the bonus, but would get back the taxes paid when you file your tax return.

  9. Teri says:

    Richard,

    I am not sure why there would be confusion. There are very different withholding rules for all types of income but most of it is just ordinary income (outside of investments usually). There is no difference in the way a paycheck or a bonus is taxed when you file your tax return, but yes withholding rules are different. Much as they are very unique for retirement distributions which are also in the end taxed the same as other ordinary income. In California rental real estate has some insane withholding rules upon the sale. Etc., etc. Much of the time withholding rules have little to do with the actual taxes owed.

    Which brings me to Lou:

    I am not sure in this particular case. One reason is to ensure you have proper withholding, in case your bonus bumps you up to a higher tax bracket. However, in many cases, extra withholdig is required merely to increase cash flow to the government. Sure they will have to pay back all that over-withholding, but it makes their bottom line look good now. I think it is a little bit of both. The bonus withholding rates has varied with time, usually in line with overall tax rates though. My educated guess is a little of both reasons.

  10. Teri says:

    Will – I am a little confused by the question. As a whole though sometimes we issue $0 checks for varying situations (maybe something should have been ran through payrol but wasn’t – a benefit or something). I think this could be another explanation. But I don’t know, I would have to know more.

    I would ask your former employer for an explanation. I don’t think they necessarily owe you anything – it should all work out in the end. But they would be better to explain than anyone else.

  11. Emilio says:

    Is anyone out there familiar with the rules for starting bonuses? What happens if you receive a starting bonus (on which you are taxed) but decide not to take the job and have to bay that bonus back to the company? Do you have to pay the part that was witheld for taxes or just the part that you received?

    For example, if your starting bonus is $5,000, you get approx. $3,000 after taxes. In the case of not taking the job, what value do you repay the company? The full $5,000 or just the $3,000?

    Thank you!

  12. David says:

    What about a gift turned into a bonus? An anonymous donor gave my employer (a non-profit) a check designated as a gift for me. My employer chose to call it a bonus and processed it through payroll. Is that proper? As I expected, the payroll person miscalculated the aggregate tax so a huge chunk was withheld. I used to do payroll, so I know how to tell the software that large one-time payments such as bonuses or retro salary increases ARE NOT part of one’s regular salary so it’s not fooled into putting you into a higher tax bracket. I hate when others don’t! Incompetent. On top of that, my employer didn’t want to get stuck with the employer-paid portion of FICA–SS & Med. (an employer has to pay another 7.65% on your salary, just like the 7.65% that is withheld from the employee’s pay) so they reduced the gross amount of the total gift. argh. Do I need to pay a payroll attorney to figure this out? I hate to look a gift horse in the mouth, but I want to make sure it’s handled properly. Thanks!

  13. Martina Riordon says:

    Do you happen to know if “commission” is considered the same as a bonus?

  14. Duane says:

    Can I request that the taxes not be with held? If so where can I find this in the tax code?

    Thanks,

  15. Andi says:

    Hi,
    Posting this because I went through at least a dozen message boards like this about bonus taxation before I found the end-all be-all documentation explaining the logic of paycheck tax withholding:
    http://www.irs.gov/pub/irs-pdf/p15.pdf
    Bonus information can be found starting on p.13 under Supplemental Wages.
    My husband was taking home only about 30% of his monthly bonuses, which are small relative to his salary. Since we’re married filing jointly and both work, he had needed to calculate a number for line 6 of his W-4 (Additional amount, if any, you want withheld from each paycheck). A worksheet gives you a lump annual amount, and you’re supposed to divide that by the number of paychecks in a year. Since his bonuses are treated like 12 extra paychecks, this same additional amount was being deducted from his bonus checks. Also the amount withheld from each paycheck was too high anyways because the total had been divided by 26 paychecks in a year instead of 38.
    This calculator was also helpful:
    http://www.irs.gov/individuals/article/0,,id=96196,00.html
    If your withholding is out of whack, this tells you exactly what to do to your W-4 to make sure that you’ve paid in the correct amount by the end of the year. It’s also run by the IRS, so it feels more reliable to me than the link in the main post.

  16. Don says:

    Let’s see: I thank God I even DID get a bonus check, and curse the fed and Charlie Crist for the flat tax.

  17. MDR says:

    Amen Don – I agree but I have to say that our whole office here in CA is in an uproar. The Fed tax just totally ate up our bonues. Doesn’t make much sense to me $69 taken out of my regular 2-week paycheck and $269 taken out of my 1-week bonus check. Ouch… I’m not looking a gifthorse in the mouth – I appreciate it but YIKES!

  18. richard says:

    Are you referring to the amount a bonus check is cut for withholding taxes or the amount it is actually taxed when you file your income tax return. I find nothing in tax laws that states bonus earnings are taxed different on tax return.

  19. Toast says:

    47% taken here in NJ on a 5 figure bonus. All I can say is OUCH!

  20. Lee Thomas says:

    I want to know why my measley bonus of $400 was so heavily taxed? They took $140 out just for federal taxes, and the rest State etc. My check netted only $222.00! This is crazy! I have one dependant at home, and the only breadwinner in this family! I make less than $40,000 a year too!

  21. Roland says:

    Not sure if this post is ever updated but I am running into this problem with bonuses too. I have moved my exemptions to ten, which helps a little but when my bonuses are getting taxed at almost 50% it’s insanity. Today on bonus of a little over $4k I paid $1800 in taxes!! And that’s not including my deductions for insurance, 401k etc. I am the head of house hold and I am supporting 3 other people. What bs!!

  22. Drew says:

    This explains what’s going on. I receive commission checks bi-weekly, but my employer classifies them as ‘bonuses’. Now I’m receiving 50% of my actual money owed me due to this new law. I was living paycheck to paycheck before and this is going to put me on the street! Who the heck wrote and approved this bill??? fire them!

  23. Visitor says:

    No, this is confusing.

    You start out talking about taxes but the problem is actually withholding.

    Bonuses are not heavily taxed; they just look that way on a paystub. When you file your taxes on a 1040 or whatever, you will treat the bonus as income just like you will treat your salary or wages, etc.

    Bonuses can, however, be subject to a high withholding rate, since many employers choose to withhold at 25% as authorized by the IRS.

    So if you don’t have a high income (so your income tax rate is lower than 25%, probably much lower) and your employer uses the flat-rate withholding method (25%), you will be getting a large refund.

    Of course, you want the money now, not next May!

  24. Christopher Morrison says:

    Thank you for this article. I was wondering why the taxes were higher than normal on the bonus I received earlier this year.

  25. A Guy says:

    My salary is a joke… and I work 50+ hours a week busting my but for a larger year end bonus that gets paid in Feb the following year… when your bonus is $30-$40,000 and you lose $14-$19,000 in taxes… well, just the thought makes me sick. How am I supposed to ever pay off all my debits like this? Screw you uncle sam.. I busted my butt for it, let me have it!

    How can I put that money in my pocket so I can finally be debit free?

  26. Skip says:

    Excellent article but unfortunately doesn’t ease the pain. I am in sales and my bonus/commission is actually more than my salary so I am always getting wacked hard with every pay check. And when your in a sales gig with a quota that is different every month it is very difficult to get a handle on how to accurately calculate deductions. I am by no means an anti tax guy but when your trying to support a family and you see almost half your check go to taxes every pay period it’s a little frustrating.

  27. Alec says:

    Its my money…….AND I WANT IT NOW.

  28. Matt says:

    I am leaving my current company and part of the policy is that I get all remaining vacation time paid to me when I leave. I am a salary employee so it’s not like I would be working over 40 hours per week (ie – 1.5 x normal hourly rate) but I’ll receive it all on one check. Think that paid vacation will be taxed as a bonus? I work in IN but live in KY.

    Thanks!

  29. Skip says:

    One other comment. I do think it easy to get confused the fact that when you do your taxes everything evens out but the issue is that the heavy taxation really hurts when much of your pay is comprised of bonuses. I also think this law is a little unfair in that it really impacts those of us that are “employees” and this part of the inherent unfairness of our tax code and our country right now. Many people that are “contractors” or people who have their own business control completely how and when they pay their taxes. In addition they have so many b.s. right offs that I have seen people making $250k plus per year pay less in taxes than someone who makes less than half that amount. Again, I know taxes are necessary to make our society run but everything seems geared to helping people who already have a lot of money keep it and for those of us trying to make our way up down.

  30. Kingsway says:

    I have read the past few years posts here with great interest. I have been working on a project that pays commission. However, it has been 3 full years of NO INCOME. Now, the deal is about to close and I will receive a commission of around 450K. How do I structure this to ensure I do not pay 40% in tax. I have starved for these three years, paid all my own expenses to make this happen. should I set up an LLC or C corp and have it paid into that? Need some direction…if anyone has experienced this type of situation. Thank yhou.

  31. Mark says:

    Not sure if this thread is still updated but I have a question. I’m a union employee and we worked for nearly 2 years without a contract. Once it was settled, we received our back pay. Our awesome govt. considers back pay to be a bonus, or supplemental which to me is BS. This is money that we were shorted for nearly 2 years. Anyways, I’ve heard that even though bonuses and such are taxed at a higher rate, is it true that once we file our tax return in the spring, we most likely get most of the withholding back because on a return its just like it was a considered part of our normal pay? If so, why does the govt tax this higher? I assume its so they can hang on to our money until we file for our return. Thanks

  32. TL says:

    You think lawmakers use reason when they do this crap??? What planet are you from?

  33. AJ says:

    Wow, you guys are morons.

    It’s the amount withheld, not your actual liability.

  34. kirk says:

    HAHAHA you understand Feds taking 25% of your money for nothing in return! You agree to this like a dumb slave…

    I can sell you a time machine for 10% of your paycheck..

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