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Annual Bonus

You earned an annual bonus. You worked hard and your employer rewarded you.

A cash bonus may be one of the best ways for employers to show appreciation for a job well done and give further motivation for continuing diligence. You look forward to getting that bonus check, you have big plans for this windfall. When you receive the check, it seems like the deposit in your bank account is smaller than you expected, here is why…

What happened…. explained!

The IRS views your annual bonus as supplemental income, extra income in addition to your normal wages, and like any other windfall, the rate that your employer uses to withhold is higher.  This does not necessarily mean you will be taxed at a higher bracket that will depend on your total income at the end of the year. However, until you file your tax return, the government will be holding that money. You may get some of it back as a refund, but that will depend on your total income and tax payments for the year.

How do employers withhold from your annual bonus?

There are two methods your employer can use to calculate how much to withhold from your bonus.

The Percentage Method:

You can think of it as the flat fee method, because it is just that, a flat 25% is withheld from your bonus. Nothing could be easier and most employers prefer to use this method.

The Aggregate Method:

That’s right it is all added together, your bonus and your regular income and withheld using the information on your W4, just like a normal paycheck. This aggregate amount is of course higher and so again it looks you got taxed more, but really it’s not, it is the “pay” that is higher.  Just think of as the difference between .05% of $10 and .05% of $100!

Last but not least!

Don’t feel too bad, those who get an annual bonus of more than a million are taxed at close to 40% federally, plus any state tax withheld.

Remember, Social Security and Medicare are also withheld from your bonus, just like your regular paycheck.  There also may be some state obligations too, depending on regulations of your state.

So congratulations on your reward. It may not be the full amount of what was on that fancy bonus letter you got, but it is a well-deserved award, and you should enjoy it!  When tax time comes you may just get some of it back, you should always consult a tax professional to help you make sure everything is handled properly.

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