Giving your employees a bonus can be a celebratory time. You get to thank them for their hard work or reward them for going above and beyond. But before you get to the best part, handing over the bonus check, you’ve got to make sure you correctly take care of the bonus in your payroll system.
Luckily, if you know some key facts about bonus taxation, you can correctly tax your bonus payments and get everything squared away so you can compensate your awesome employees correctly.
3 best ways to handle bonus payroll
You have two main options for taxing and processing a bonus: run a separate bonus payroll or include the bonus in your regular payroll run. These methods are also sometimes referred to as the percentage method and the aggregate method.
1. Run a separate bonus payroll
To use the percentage method of withholding for a bonus, you typically need to run a separate bonus payroll (i.e., the bonus amount would be on a separate check and not included with the employee’s regular pay). With the percentage method, you will be withholding federal income tax at the flat supplemental withholding rate, which is 22% in 2021 (and not expected to change for the next few years).
This is the rate for all employee bonus pays under $1 million. Of course, the bonus is also subject to other regular payroll taxes.
The percentage method of withholding is a little bit easier than the aggregate method because it uses a flat percentage. If your employee is in a tax bracket that is the same or higher than 22%, it is typically also what they would choose, as their withholdings could be higher with the aggregate method.
However, if your employee is in a much lower tax bracket, this method could result in over-withholding. That isn’t the end of the world, as they will get the money back in a refund when they file their taxes, but it could be a better option to use the aggregate method in that case.
2. Include a bonus in your regular payroll run
When using the aggregate method of withholding, you will be including the bonus with an employee’s regular wages (but the bonus will be denoted). The aggregate method is a little more complicated than the percentage method but still doable, especially if you have some help with the calculations from your payroll provider.
To calculate taxes with the aggregate method, first, calculate the amount of federal income tax to withhold on the entire amount, bonus, plus regular paycheck. Then calculate the amount to withhold on just the regular wages. Finally, subtract the second value from the first value to get the amount of taxes to withhold on the payroll.
3. Lump the bonus in with regular wages
There is technically a third option: you could increase your employee’s regular wages and not say that you are giving them a bonus. This would mean that you regularly withhold on all the wages, “bonus” included. While this may seem like an easy option, not denoting the bonus could cause confusion with your employee and cause trouble with the IRS.
The IRS typically treats bonuses as “supplemental wages,” which is why they have a supplemental withholding rate. If you lump a bonus in with regular wages, it could also lead to incorrect tax withholding and reporting, which would be a burden for you and your employees.
If you need help with processing your payroll, Homebase Payroll software is here to assist you with handling your paperwork and bonus tax rates. When you sign up, you can onboard employees, track their time, and run payroll, all in one place.
Bonus payroll FAQs
Are holiday bonuses taxed?
Yes, holiday bonuses are taxed as they are considered compensation, but at a different rate than the regular pay.
How are year-end bonuses taxed?
If a year-end bonus is included as a part of a standard payroll check, it will be treated the same as regular taxable income. If an employer chooses to include a year-end bonus on a separate check, it will be taxed at a flat rate – 22%.
What is the difference between overtime pay and a bonus?
Overtime pay is a non-discretionary bonus that an employee is entitled to receive based on the number of overtime hours they clocked-in in a workweek. On the other hand, an employee bonus is optional and is offered as an incentive or an award for their contribution.
