How Taxes on Bonuses Work

There’s nothing like hearing the news that your hard work has paid off, and you’re receiving a bonus as a token of appreciation. Your celebration might be short-lived when questions about taxes on bonuses fill your mind.

Now, it's completely normal for your excitement to take a pause when you start pondering the tax side of things. The good news is that understanding it doesn't have to be complicated. So, let's dive into how bonuses and taxes work.

What’s a bonus?

Think of it as a bonus high-five for going above and beyond. It could be a sweet cash reward, gift card or even some company stocks. It's basically a way for your workplace to show gratitude for your efforts and give you a little extra cheer for your accomplishments. It's not your regular paycheck, and makes your hard work feel even more valuable.

Is every type of bonus taxed?

Most types of bonuses are taxable. Whether it's a cash bonus, a gift card or stocks, the IRS wants a share of your prize. It's like a universal rule – if you receive something extra from your workplace, there's a good chance you need to pay taxes on it.

Special rules may apply to non-monetary gifts, and it’s best to check with your CPA for expert advice on whether it’s taxable.

The specific tax treatment can now depend on the bonus type and the local tax regulations. Cash bonuses, for example, are pretty straightforward. A portion is set aside for taxes before it reaches your hands.

Non-cash bonuses, like gift cards or stocks, also usually have a tax tag attached. The value of these goodies is considered income, meaning a slice of it is set apart for taxes.

There are some exceptions, though. Some non-cash bonuses might avoid taxation if they fall under certain categories, like de minimis fringe benefits. But, as with all things tax-related, it's wise to check in with a tax pro for the specifics.

De minimis fringe benefits are those small, infrequent and administratively impractical perks provided by employers considered so minor that accounting for them would be unreasonable. These benefits are often excluded from taxable income. Here are some examples:

• Occasional snacks or coffee: Providing occasional snacks, coffee or other refreshments in the workplace
• Holiday gifts: Small gifts given to employees on holidays or special occasions, such as a turkey at Thanksgiving or a gift basket at Christmas
• Occasional transportation services: Offering occasional taxi rides or shuttles for employees working late or during special events
• Celebratory events: The cost of occasional office parties, picnics or other celebrations for employees
• Lunches or meals: Providing occasional meals for employees, especially during busy periods or as a form of recognition
• Discounts on company products: Small discounts on goods or services provided by the employer, such as discounts on company products

How is a bonus taxed?

The IRS considers a bonus as another source of income, meaning it’s taxable and is taxed the same way as your other sources of income.

If your bonus is $1 million dollars or less, your bonus will be included in your normal pay and taxed as regular payroll withholdings or a flat withholding rate of 22% as part of the percentage method. This is one of two methods your employer can use to figure out how much taxes are withheld from your bonus.

Let’s say you received a $4,500 bonus working as an accountant for Uber. You’re taxed at the 22% flat withholding rate, meaning you multiply $4,500 x .22 = $990. So, $990 is sent to the IRS to cover the taxes for your bonus.

If you receive a bonus that’s more than 1 million dollars, you’ll pay 22% on the first million and 37% on the rest.

The aggregate method is another option your employer can use when your bonus and regular wages are included in one paycheck. Taxes are withheld on the entire aggregated or combined paycheck all at the same rate.

How can I lower the taxes on my bonus?

One way to save on bonus taxes is to use the funds to contribute to your 401(k) or similar retirement accounts.

You can also use the funds to contribute to your Health Savings Account (HSA) to reduce the taxable bonus amount.  

Tax deductions and credits are always the most optimal options to save on 1099 taxes.

What if I overpay on my bonus taxes?

The good news is that if you accidentally overpay on the taxes for your bonus, you should expect to receive a refund for the extra amount. It’s always best to consult a tax expert in cases like this. The CPA team at FlyFin is there to help you with every step of the tax filing process. Plus, with the help of A.I., you’re sure to never miss out on a single tax deduction again.