How Should You Tax a Bonus Payment?
If you’re following the continuing saga of the financial meltdown, you might be under the impression that many employers are doling out seven-figure bonuses like Goldman Sachs, Bank of America, AIG and the rest.
In reality (as has become crystal-clear over the past year or so), Main Street isn’t Wall Street, and operates on much more traditional principles. So as you would expect, the number of employers that are still paying out bonuses during this recession has dropped substantially …as has the relative size of the average bonus. But there are still companies doing well enough to use this vehicle to reward their top employees; and if yours is among them, we wanted to provide you with a cautionary note on the subject.
Most companies want to maximize the psychological impact on their bonus-eligible employees; and some do so by skipping withholding Federal income tax on the bonus,
thereby making the take-home portion appear as large as possible. It’s probably no surprise that Uncle Sam doesn’t much care for that approach. Further, you risk putting your top employees in a serious crack come April 15th, when at best they may owe a penalty and at worst may be unable to pay their tax due. Few wage workers have the discipline required to make an estimated payment, or minimally to sequester the sizable amount out of that windfall bonus that isn’t really theirs.
The right way
What you should do is withhold Federal income tax from bonuses at the supplemental tax rate of 25.00% (in fact, 35% for those fortunate enough to be receiving a 7-digit bonus); or else the withholding should be calculated as if the latest pay check and the bonus were on the same paycheck.
It doesn’t provide employees with quite as big a holiday surprise, but it also doesn’t set them up for a potential shortfall in April. And in fact, come April they’ll probably get yet another nice surprise …because in all likelihood they’ll be over-withheld, and will thus get a nice “mini-bonus” in the form of their Federal tax refund.