Why is My Bonus Taxed At Such a High Rate?

By: Alex Franch, BS EA

Were you lucky enough to get a holiday bonus, but noticed it was much smaller than you expected after taxes were taken out? Here’s an example of why this happens.

Let’s begin with a taxpayer (let’s call him Mr. Banks) who makes $96,000 annually, or $8,000 per month. Mr. Banks is married, with no dependents. At this rate, his employer (let’s call it the Dawes Tomes Mousley Grubbs Fidelity Fiduciary Bank or DTMGFFB) looks at the payroll tables and calculates a Federal Withholding of $1,133 per month. They withhold an additional $1,028 in payroll tax and Massachusetts income tax. So Mr. Banks has a take home pay of $5,839 every month from January to November.

Ho, Ho, Ho, Bonuses for Everyone at DTMGFFB

BonusDTMGFFB announces bonuses for everyone in December. Mr. Banks is expecting a $5,000 bonus but when he opens his paycheck, it has only gone up by $3,000. Why? When the computers at DTMGFFB see the Gross Pay for Mr. Banks as $13,000 for the month of December, they naturally assume that Mr. Banks is going to make $156,000 for the year ($13,000 x 12 months). DTMGFFB withholds $2,383 to the IRS and an additional $1,671 for payroll taxes and Massachusetts income tax. Mr. Banks has a take home pay of $8,946 in December. On the plus side, Mr. Banks can now grouse about the tax man at every holiday meal. Merry Christmas Mr. Banks.

What Should be Withheld if the Bonus Was Spread Out All Year Long?

If instead, Mr. Banks received a $5,000 raise rather than a December bonus. Mr. Banks would have a monthly income of $8,417 or $101,000 for the year. At this rate, DTMGFFB would withhold $1,238 in Federal tax plus $1,081 in payroll and Massachusetts income tax. Mr. Banks would have a take home pay $6,098 every month from January to December.

What Difference Does a Bonus Make?

In this case, not much, since Mr. Banks has virtually the same take home pay in both cases:

  • $5K Bonus: $5,839 x 11 months + $8,946 = $73,146
  • $5K Raise:  $6,098 x 12 = $73,176

But depending on the size of the bonus, the amount of your regular salary, and current IRS tax brackets, the difference could be far more than the extra $30 that Mr. Banks had to pay.

Luckily, that’s your money, not the government’s. Miscalculated withholding doesn’t change how much tax you actually owe, so the IRS will have to pay you back when you file your tax return.

Why the Bonus Instead of a Raise?

The company does not know how much it can afford until it is about to close its books in December. What I can tell Mr. Banks is, a spoonful of sugar helps the medicine go down.

Need Advice? Contact Us

Are you giving your employees a bonus or are you expecting one? Maybe you are not sure how to work through the tax implications of the bonus? Call Alex Franch at 781-849-7200,

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