Here’s Why Bonuses Are Taxed Differently
Just noticed you received a little extra money in your paycheck — AKA a bonus? Your first reaction is probably something like “Yassss!” until you realize that the government taxed the shit out of that bonus, and maybe even the entire paycheck. Before you call up payroll, take a breather. We’re about to explain why this happened, because no, payroll didn’t mess up your paycheck. Bonuses are, in fact, taxed differently from your normal salary.
Why are bonuses considered different from normal income?
Tax situations vary more widely when you get down to state and city taxes, but we’re not going to go over those today because, TBH, they’re all over the board. So we’ll stick to the federal level. According to the IRS, bonuses are considered supplemental income. The IRS also recognizes that there are lots of different forms of supplemental income, like overtime pay, commissions, severance pay, awards, prizes and accumulated sick leave.
Supplemental income is not held to the same taxing standards as regular income like a bi-weekly paycheck because supplemental income is situational, unlike salary. You’re paid the same amount in salary assuming you don’t get a raise or change your withholding tax information, whereas a bonus can be any amount (the amount matters, but we’ll get to that later). Your employer also has the option to combine the bonus with your bi-weekly salary pay or pay it to you separately. (And, those options have different tax obligations. We’ll also get to this later). You also could scrap the whole relation to salary wages if you’re a contracted or non-salary employee. Basically, there are too many different situations in which the bonus can be given, and as a result, the IRS can’t put a stamp on them all with the same tax rule.
Okay, so what are the situations and how are those situations dealt with in taxes?
When your clients or employers decide to give you a bonus, they have multiple options. They can lump it in with your scheduled pay (like a bi-weekly salary or freelance pay for a completed project) or they can pay it out to you separately from your scheduled pay. The result? You could either have a bonus tax that is higher, or even sometimes less, than what your taxed on your normal paycheck.
If your bonus is lumped into your paycheck: Your entire paycheck, which includes the bonus, could be taxed as though you were in a higher tax bracket.
If your bonus is paid separately from your paycheck: Employers or clients can choose from three options when they give you a bonus:
1. Your employer withholds a flat 22-percent tax from the bonus while your paycheck is taxed as normal.
2. Your employer or client pays you your bonus concurrently with your paycheck (meaning not lumped into your paycheck, but at the same time as your paycheck), and you’re taxed as if your bonus was lumped into your paycheck.
3. If you aren’t a salaried employee and instead are a freelancer or contractor, you’ll only have one option. Instead of being immediately taxed on your bonus, you’ll have to adjust your W-4 to include more allowances, depending on how much the bonus is.
Sorry if we completely ruined your happy mood on the bonus situation by throwing confusing explanations in your face. The good news is that you got the bonus, right?! Hold onto that and be happy — you’re in a solid spot. Consider saving that money in your emergency fund, stashing it into your retirement account or even investing it so that you can set yourself up for financial success later.
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