The good news is that you might get a portion of that money back when you file your tax return for tax years 2022 and 2023. It’s no different from withholding too much from your paychecks during the course of the year. The IRS will issue you a refund for any excess.
Bonuses Are Supplemental Wages
The IRS classifies bonuses as supplemental wages. Supplemental pay is pretty much anything other than your regular pay—severance pay, taxable fringe benefits, and vacation pay, for example. It’s subject to its own withholding rules that depend, to some extent, on how your employer pays you the money. Bonuses might be subject to their own withholding rules, but they’re treated just like your other ordinary income at tax time when you file your return, and they’re included in your taxable income. Your tax brackets and their applicable rates are based on that income.
How Are Bonuses Taxed?
Your employer has two withholding options it can pick: the percentage method or the aggregate method.
The Percentage Method
The percentage method is a flat 22% for both 2022 and 2023. No other percentage can be used. Your employer can simply withhold the flat 22% that’s applicable to all supplemental wages under $1 million. This rate would result in $660 in taxes on a $3,000 bonus. The 22% method applies to your bonus income even if your regular wages fall into a tax bracket that’s greater or less than 22%.
The Aggregate Method
This option is more complicated. Withholding based on the aggregate method is first calculated on your regular pay plus your bonus pay, based on the information you provided to your employer on your Form W-4 and the IRS withholding tables. The same rate of withholding is calculated on just your regular income. This figure is then subtracted from the withholding on the total combined amount of regular income and bonus. The result is then withheld from your bonus. Let’s say your regular pay is $1,000, and withholding on that pay is $50. Your employer then gives you a $3,000 bonus, all in one paycheck. It works out like this: You’re now subject to $300 withholding on the total combined wage and bonus income of $4,000. Your employer would subtract your regular withholding of $50 from that $300 and would then withhold the balance of $250 from your $3,000 bonus.
Tax Treatment of Bonuses of More Than $1 Million
Now let’s assume that you’re an executive at a company and you get a $1.5 million bonus. The first $1 million is subject to the 22% withholding rate that applies to bonuses and supplemental wages paid in the 2022 or 2023 tax year. Just like that, your bonus shrinks to $1.28 million because $220,000 goes to the IRS right off the top. The $500,000 you received over $1 million is subject to withholding at the rate of the highest tax bracket for that year: 37% in 2022 and 2023. That’s another $185,000 that goes to the IRS. Your total withholding on that $1.5 million works out to $405,000: $220,000 at the 22% rate, plus $185,000 at the 37% rate, leaving you with $1,095,000.
Exceptions to Bonus Rules
The percentage and aggregate methods don’t apply when you receive your bonus lumped together with your regular pay, all in one check, and if your employer doesn’t specifically make note that the bonus amount is separate and apart from your regular pay. The total (your bonus plus regular wages) is subject to withholding just as though it was all your regular pay in this case.
Incentive Payments Are Different
Incentive payments aren’t considered regular income, so they’re subject to different rules. They’re reported in Box 3 on the 1099-MISC form as “other income,” not on Form W-2 with other wages and payments from which taxes are withheld. Income tax isn’t withheld from incentive payments, although they’ll be included with your taxable income when you prepare your tax return. You don’t have to pay Social Security or Medicare taxes on incentive payments, however.
Which Method of Tax Withholding on Bonuses Is Best?
Generally speaking, the percentage method is a lot easier for your employer. As for which benefits you the most, it might come down to your tax bracket. The withholding on your bonus is going to be more using the aggregate method if you’re in a tax bracket that is higher than 22%, such as the 24% or 32% bracket. It’s something of a wash if you’re in the 22% bracket. And if you’re in the 12% bracket? Your taxes will likely be lower than the 22% method.
What if Too Much Tax Is Withheld from Your Bonus?
So let’s say that you prepare your tax return, and it turns out that what was withheld from your bonus was way too much based on your end-of-year tax rate on your taxable income. The IRS will issue you a refund for the money withheld from your bonus if it turns out that the 22% rate was too much based on your overall income at year’s end. Your Form 1040 tax return would show an overpayment of taxes, just as it would if you overpaid through withholding from your regular wages. The IRS refunds any difference between what you paid and what you actually owe.
