Bonuses and How to Tax Them
Often times when a bonus is paid, an employer will just add the amount to a payroll item, name it something like “bonus” and add it to the normal payroll run. That is fine if you know that the payroll software is using the “Aggregate Method” of income tax withholding for the underlying calculation.
When comes to income tax withholding on bonuses, there are two authorized different methods:
1. The Percentage (supplemental rate) and
2. the Aggregate.
The Percentage Method is currently just a flat 25% of anything supplemental to your employees' wages. For example, if you give an employee a $1,000 bonus, $250 is taken out for federal income taxes (states may have different rules).
The Aggregate Method happens when you add a bonus to your employee’s most recent paycheck. Then, you must determine the withholding for both amounts, subtract what was deducted from his or her last check, and then withhold the rest from the bonus.
IMPORTANT: Supplemental wages are subject to a more rigid set of rules for determining the amount of withholding. If the supplemental wages paid to an employee during a year exceed $1 million, the amount of supplemental wages in excess of $1 million is subject to withholding at a flat rate that is currently 35%. Under this method, withholding is computed without regard to any exemptions or allowances claimed by the employee. This is referred to as the “mandatory flat rate procedure.”
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