You may consider a bonus from your employer to be “free money,” but it’s not entirely free. Although the extra padding in your end-of-the-year paycheck may help get you through the holiday shopping frenzy, a holiday bonus has a tax liability attached to it. The same is true of almost any bonuses you receive. You’ll still net part of the bonus, but you won’t receive the entire amount.
With few exceptions, the bonuses you receive from your employer must be included in your gross income each year and, therefore, subject to income taxes.
Calculating Employment Bonus Tax Rates
The IRS defines bonuses as “supplemental wages.” Even though the amount of a bonus is in addition to your hourly or salaried compensation, it supplements your regular wages. Bonus tax rates depend on how your employer pays you. If you receive a separate check for your bonus other than your regular paycheck, the amount of your 2018 bonus is taxed at a flat rate of 22 percent. For example, if your bonus is $1,000, $220 is deducted for federal income taxes by this “percentage method.”
And if you think this method takes a hefty bite out of your bonus, you'll likely pay even more in taxes if your employer includes your bonus in your regular paycheck, using the “aggregate method” of withholding. This calculation first applies the withholding rate for the combined amount of your paycheck plus your bonus. Next, your employer subtracts what was withheld from your last paycheck before withholding the rest from your bonus amount. The result is a higher tax liability on the same amount of bonus money simply by using a different calculating method.
The state where you live may take another piece of your bonus check pie. Aside from federal taxation of bonuses, each state imposes its own bonus tax rate. If you live in a state that doesn't tax income, you'll only owe the federal tax liability on your bonus.
If you receive a non-cash bonus, such as a vacation trip, you must add the fair market value of the trip to your gross income when you file your tax return (unless your employer has already included this on your W-2).
Bonus Tax Rate Exceptions
If you receive a non-cash employee achievement award for your length of service at a company or a safety reward, you don’t typically have to include the fair market value of the award in your income or pay taxes on it. For example, if you receive a watch for your service to a company, you do not have to include its value as part of your income, as long as you’ve been an employee for more than 5 years and the watch’s value is less than $1,600. Visit IRS.gov and search for Publication 525, which fully outlines allowable tax-exempt employee bonuses and awards.
In addition, many de minimis fringe benefits are also excluded from income taxes. From the Latin word for "concerning trifles (or little things)," de minimis simply refers to those small bonuses that have negligible value. As long as your company doesn't shower you with these small benefits throughout the year, occasional theater tickets or a gift basket on your birthday are bonuses that do not have to be included in your gross income. The rule of thumb is that a de minimis gift cannot carry a value over $100.
2018 Bonus Tax Rate
Although the percentage method of calculating income tax on your bonuses assesses a 22 percent tax, this applies to taxpayers that make less than $1 million in 2018. If you make more than $1 million, you'll pay 37 percent tax on the amount that exceeds $1 million in addition to the 22 percent tax on the amount less than $1 million.
2017 Bonus Tax Rate
If your income was less than $1 million in 2017, you'll owe 25 percent tax on your bonuses. If you made more than $1 million, you'll owe 39.6 percent tax on the amount that exceeds $1 million in addition to the 25 percent tax on the amount less than $1 million.