What is a bonus?
A bonus is extra pay or compensation that an employer gives beyond an employee’s regular wage or salary. It can be cash, shares, stock options, gift cards, extra time off, or other rewards. Bonuses are used to reward past work, encourage particular behaviors (like staying with the company), attract new hires, or share company profits with employees or shareholders.
Common types of bonuses (definitions)
– Signing bonus: A one-time payment offered to a new hire to incentivize them to accept the job.
– Referral bonus: Paid to an employee who successfully refers a person who is then hired.
– Retention bonus: Money paid to a worker to encourage them to remain employed during transitions or difficult periods.
– Performance bonus: Awarded for hitting performance goals; can be annual, quarterly, project-based, or a spot (immediate) award.
– Holiday bonus: A seasonal gift or payment given around holidays; in some countries it is legally required (e.g., the Aguinaldo/“thirteenth salary”).
– Bonus issue (share dividend): Free additional shares issued to existing shareholders, sometimes called a stock dividend.
– Bonus in lieu of pay: A payment made instead of raises or salary increases; may be temporary or contractual.
How bonuses are treated for tax and payroll
In many jurisdictions, bonuses are treated as taxable income. In the United States, the IRS considers bonuses taxable and employers must report them and withhold taxes. Employers may use special withholding methods for supplemental wages (such as a flat supplemental rate or aggregate with regular wages); the final tax owed depends on total annual income and the taxpayer’s filing situation. Employers also withhold payroll taxes (e.g., Social Security and Medicare) on bonuses.
Why employers give bonuses
– To motivate or reward employees for performance and loyalty.
– To attract candidates in competitive labor markets.
– To retain critical staff through organizational change.
– To share company profits or to distribute equity to shareholders.
Important practical points
– Size varies widely: spot bonuses for small recognition can be modest (e.g., tens of dollars); executive bonuses often run much larger and may be tied to company results.
– Bonuses can be conditional (vesting schedules, clawback clauses, or repayment if the employee leaves within a set period).
– If a bonus is paid in stock or options, its tax timing and character (ordinary income versus capital gains) depend on grant type and whether the stock is sold.
– Some jurisdictions legally require holiday bonuses or equivalent payments; check local labor law.
Short checklist: What to verify when you’re offered or expecting a bonus
1. Is the bonus one-time or recurring? (annual, spot, signing, retention)
2. Is it paid in cash, stock, options, or other forms?
3. Are there vesting rules, clawback, or repayment conditions?
4. How will taxes and payroll deductions be handled? (withholding method, estimated net)
5. Does the bonus affect benefits tied to salary (e.g., pension contributions, overtime calculations)?
6. Is the bonus specified in your contract or company policy, or is it discretionary?
7. For shareholder bonuses, what does a bonus share issue mean for share count and ownership percentage?
Worked numeric example (U.S. payroll illustration)
Assumptions (hypothetical; for illustration only):
– Gross cash bonus: $5,000.
– Employer uses the flat supplemental federal withholding rate of 22% for bonuses under $1,000,000.
– Employee payroll taxes (Social Security + Medicare) withheld at 7.65% (employee share).
Step calculations
Step calculations (continue)
1) Federal withholding (flat supplemental rate)
– 22% × $5,000 = $1,100
2) Employee Social Security & Medicare (FICA employee share)
– 7.65% × $5,000 = $382.50
3) State income tax (assumption in base case: none). If present, add the appropriate percent.
4) Net cash bonus to employee (base case, no state tax)
– $5,000 − $1,100 − $382.50 = $3,517.50
Alternate illustrations
A. Employer uses the aggregate withholding method
– If your normal marginal withholding rate is 24%, the employer might add the bonus to your most recent regular paycheck and withhold at that rate for the combined amount.
– Federal withholding: 24% × $5,000 = $1,200
– Employee Social Security & Medicare (FICA employee share) – 7.65% × $5,000 = $382.50
– State income tax (assumption in base case: none). If present, add the appropriate percent.
– Net cash bonus to employee (aggregate-method example, no state tax) – $5,000 − $1,200 − $382.50 = $3,417.50
Comparison (same bonus, no state tax)
– Flat supplemental method (22% federal): net = $3,517.50
– Aggregate method (24% federal): net = $3,417.50
– Difference to employee: $100 less net under the aggregate withholding example because federal withholding was higher.
Other practical points and variations
1. High bonus amounts. If a single supplemental payment to one employee in a calendar year exceeds $1,000,000, the IRS requires withholding at the highest rate (currently 37%) on the portion above $1,000,000. Verify current thresholds and rates before assuming them.
2. Employer payroll taxes (employer side). Employers generally must pay matching FICA on bonuses (7.65% in our example) plus applicable federal and state unemployment taxes. These are paid by the employer and do not reduce employee net pay but affect employer cost.
3. Additional Medicare tax. Employees with earnings above the applicable threshold ($200,000 single; other thresholds for married filing jointly/head of household) may be subject to an additional 0.9% Medicare tax on wages above the threshold. Employers must withhold this additional tax when wages exceed the threshold, regardless of marital status.
4. Reclaiming over-withheld amounts. If withholding on a bonus exceeds what you ultimately owe for the year, you can recover the excess by filing your annual income tax return (Form 1040). Conversely, under-withholding may result in tax due or penalties.
5. Payroll reporting. Bonuses are treated as wages for reporting purposes and appear on Form W-2. Employers must include them in wage totals and applicable boxes for Social Security, Medicare and federal income tax withheld.
Quick checklist for employees who receive a bonus
– Check your paystub to see whether the employer used the flat supplemental rate or aggregated the bonus with regular wages.
– Confirm federal withholding amount and FICA withholding (Social Security and Medicare).
– Note any state income tax withheld and any additional Medicare tax.
– Estimate after-tax cash using the same arithmetic shown above; if you expect a large tax bill, consider setting money aside.
– If you believe withholding was done incorrectly, speak with payroll or a tax professional; file your tax return to reconcile withholding.
Worked numeric example (recap)
– Bonus: $5,000
– Flat federal method: 22% × $5,000 = $1,100; FICA 7.65% × $5,000 = $382.50 → Net = $3,517.50
– Aggregate-method example (24% marginal rate): 24% × $5,000 = $1,200; FICA = $382.50 → Net = $3,417.50
Assumptions and caveats
– This example assumes: current flat supplemental federal withholding rate is 22%, employee FICA share is 7.65%, no state income tax, and no Additional Medicare Tax applicability. Rates, thresholds, and rules can change; consult the latest guidance.
– This is educational information, not individualized tax advice. For personalized tax planning, consult a qualified tax professional.
Selected references
– IRS — Topic No. 753: Supplemental Wages (including Overtime): https://www.irs.gov/taxtopics/tc753
– IRS — Publication 15 (Employer’s Tax Guide): https://www.irs.gov/publications/p15
– Social Security Administration — Information on Social Security taxes: https://www.ssa.gov
– Investopedia — Bonus
– Investopedia — Bonus: https://www.investopedia.com/terms/b/bonus.asp
– IRS — Publication 505 (Tax Withholding and Estimated Tax): https://www.irs.gov/publications/p505
Notes
Notes
1. Definitions used above:
– Supplemental wages: payments that are not regular wages, such as bonuses, commissions, overtime, severance, and back pay.
– Supplemental withholding (flat-rate method): a specific federal withholding approach where employers may withhold a flat percentage of supplemental wages instead of calculating withholding on the combined pay.
– Aggregate method: an alternate employer method where the employer adds the bonus to the employee’s most recent regular wage and withholds as if the total were a single payment for the regular payroll period.
2. Payroll-tax treatment: Bonuses are subject to federal income tax, Social Security tax (part of FICA, the Federal Insurance Contributions Act), and Medicare tax. They are also subject to state and local income tax where applicable. Employer payroll-tax obligations (the employer share of FICA, FUTA, etc.) apply the same as for regular wages.
3. Reporting: Employers report bonuses on Form W-2 as wages in Box 1 (federal income tax), and also include them in the Social Security and Medicare wage boxes where applicable. Large bonuses can affect Medicare Additional Tax withholding thresholds and the timing of reported wages.
4. Withholding vs. final tax liability: The amount withheld from a bonus is an estimate toward your eventual tax bill. Your final tax owed or refund is determined on your annual tax return using total income, deductions, credits, and filing status. Withholding methods can produce different withholding amounts for the same bonus; none change the ultimate tax computation other than timing.
5. Changes over time: Tax rates, withholding rules, and thresholds change periodically. The flat supplemental withholding rate and payroll-tax rates used in examples are for illustration; check current IRS guidance for up-to-date numbers.
Frequently asked questions (short answers)
– Are bonuses taxed at a higher rate than regular pay?
No. Bonuses are taxed under the same federal income tax system, but the way employers withhold (flat-rate vs. aggregate method) can make it seem like bonuses are taxed more heavily at the time of payment.
– Which method will my employer use?
Employers may choose either the flat-rate method or the aggregate method for federal withholding on supplemental wages; some employers have policy preferences and some payroll systems default to one method.
– Can I adjust withholding so less is taken from my bonus?
You can submit a new Form W-4 to change your overall withholding for future paychecks. For a one-time bonus, practical options are limited; you cannot instruct an employer to use the aggregate method if the employer’s policy is the flat method, but the employer must follow IRS rules.
– Does a bonus affect Social Security/Medicare withholding?
Yes. Bonuses count toward Social Security and Medicare wages and are subject to the same percentage rates as regular wages. Social Security has an annual wage base limit; once reached, no further Social Security tax is withheld for that calendar year.
Practical checklist — If you receive a bonus (employee)
1. Confirm the type of payment: