There's nothing like the feeling of being told you're getting a bonus and reveling in your newfound wealth. But countless first-time bonus recipients inevitably wind up disappointed when they look at their actual checks and realize how little money is left after taxes. Because bonuses are often taxed at a higher percentage than ordinary earnings, the amount you get in hand might be considerably less than the amount your employer originally promises. Knowing what to expect out of your bonus -- and how much you'll lose to the IRS -- can help you avoid disappointment.
How are bonuses taxed?
Your ordinary earnings are taxed based on your marginal tax rate. The more money you earn, the more you'll be taxed on your highest dollars of income.
Bonuses work a little bit differently. Bonuses are considered supplemental wages, and, as such, are subject to a different method of taxation. Most employers tax bonuses via the flat tax method, where an automatic 25% tax is applied to your payment. (Note that bonuses that exceed $1 million are subject to an even higher rate of 39.6%.)
Now 25% may not seem like all that much, but if your marginal tax rate is only 15%, you're going to feel the difference. Furthermore, that 25% doesn't take Social Security and Medicare taxes into account, as well as state taxes. After all is said and done, you could easily end up losing close to 40% of your bonus amount to taxes.
Now not all employers use the flat tax method for taxing bonuses. Some use the aggregate method, where bonuses are tacked on to your regular earnings, and you're taxed on the aggregate amount. But because the flat tax method is less complex, it tends to be widely employed.
How much of your bonus will you lose to taxes?
Figuring out how much cash you'll actually wind up with can help you make the most of your bonus, and to that end, we have a calculator that can help.
Imagine you're a single employee claiming one allowance with no pre- or post-tax deductions. If you're eligible for a $10,000 bonus, you might only come away with just over $6,000 of it once taxes are applied.
Before you get too bummed, however, consider that you might end up getting some of that money back down the line. If, for example, you itemize on your return and have a large number of deductions for the year, you may end up getting a chunk of your bonus back in the form of a tax refund. And though you will have to wait on that money, at least it'll come through eventually.
Think before you spend your bonus
It's often the case that your employer will inform you of your bonus amount weeks or months before that check actually comes in. If that happens to you, it's natural to start making plans for how you'll spend that money -- but before you do, make sure to take taxes into account.
If, for example, you're eligible for a $10,000 bonus that will only translate into roughly $6,000 of actual cash when that payment comes in, assuming you'll have $7,000 to work with could seriously derail your plans. In fact, it's especially crucial not to spend your bonus money before you actually have it in hand. Though you might think you're good to charge up a storm on your credit card knowing you'll have a means of paying it off at month's end, if your bonus payout is lower than expected, you'll risk racking up debt. You're far better off being patient and waiting to see how your bonus fares in the face of taxes.