Businesses typically pay fixed wages and salaries to employees, but they can also choose to give out additional compensation in the form of commissions, awards, prizes and bonuses. The Internal Revenue Service considers bonuses to be a form of "supplemental wages." Supplemental wages are subject to special tax withholding rules that hold back or deduct a portion of bonus income to pay taxes due. The amount of a bonus check that you actually receive depends on the size of the bonus, how it is paid and your annual income.
Some companies combine supplemental wages like commissions, awards and bonuses with normal wages and do not specify the amount of normal wages and supplemental wages. If your employer combines wages and supplemental income, it withholds income tax as if the total compensation you receive is a single payment for the payroll period. In other words, with combined pay, tax withholding is simply based on your total income level.
When a company identifies bonuses and other supplemental income separately from regular wages, it can choose between one of two tax withholding methods. The first option is a flat income tax withholding rate of 25 percent. The second option is treating the total of the regular wages and supplemental wages as a single payment and withholding taxes based on that amount. If your employer chooses the second option, you could face tax withholding as high as 35 percent.
The Internal Revenue Service imposes special withholding rules on large bonuses. If you receive more than $1 million in bonuses and other supplemental wages during a calendar year, your supplemental wages in excess of $1 million face an automatic tax withholding rate of 35 percent. This rate applies regardless of tax exemptions you claim on Form W-4. The first $1 million faces either the 25 percent rate or the withholding rate based on your annual income.
Bonus income is subject the Federal Insurance Contributions Act, which includes taxes for Social Security and Medicare. Your employer has to subtract Social Security and Medicare tax from bonuses and other wages. The Social Security tax rate is 10.4 percent in 2012: employers pay 6.2 percent and employees pay 4.2 percent. Social security tax applies to the first $110,100 of income you earn, so if you make more than $110,100 in normal wages, your bonuses aren't subject to Social Security tax. Employers and employees each pay a tax rate of 1.45 percent for Medicare; there is no income limit for Medicare taxes.