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Updated: March 1, 2023
A bonus is a form of additional compensation that goes above and beyond what an employee typically receives in their paycheck. Bonuses are a nice way to thank and acknowledge outstanding employees for their hard work or for exceeding job expectations.
In addition, bonus pay is an important way to let your most dependable — and long standing — employees know how much you value their efforts (and may prevent them from looking for greener pastures). When it comes to awarding bonuses employers, typically reward top performers with a lump sum that is added to their regular pay on payday via direct deposit. Though bonuses can also be distributed in the form of a paper check.
While paying bonuses is fairly straightforward, it’s important to understand the tax requirements that apply to this form of compensation. Here’s a closer look.
Just like regular wages, taxes must be taken out of a bonus because Uncle Sam considers them income. The way in which you calculate tax withholdings on bonus payments varies depending on how you award them to employees. If you award bonuses to employees as a separate payment and do not commingle the money with regular wages, the simpler flat bonus method can be used to determine federal withholding taxes.
Pros of the flat rate method: This approach is the most straightforward and therefore simplest for you as the employer to apply.
Cons of the flat rate method: This approach may not be the most appealing to your employees. This is because most people are not in the 22% tax bracket. For employees who are high earners, the 22% percent tax may not be enough and thus the employee will end up with a surprise tax bill at year’s end. Meanwhile, for lower earners, the 22% tax may be too high.
In IRS lingo, bonuses are called “supplemental wages,” which means it’s money that an employee receives, in addition to their regular salary. When it comes to ensuring you’re applying taxes to bonuses properly, there are two ways to withhold income taxes: flat bonus calculations and aggregate.
If you choose to pay a bonus as part of a normal paycheck, you’ll treat the total of the regular wages and supplemental wages as a single payment for tax purposes. In this “aggregate tax” approach, the employee’s normal tax rate will apply. The IRS Publication 15-T can help you determine how to do this in detail, or click here for our aggregate bonus calculator.
Pros of the aggregate method: The aggregate method tends to be more accurate, so employees are not stuck with a surprise tax bill or too much taxes being withheld.
Cons of the aggregate method: This approach takes slightly more effort for you as the business owner to calculate.
Jill is new to the team, but she has had an outstanding year. She has increased productivity and cut costs in her department by 10% this year. As a way to say thank you for her hard work, you decide to award Jill a $5,000 bonus, separate from her regular wages. Her salary is $72,000 annually , or $6,000 per month.
Since the bonus is being paid separately, you simply withhold a flat 22% for Jill’s federal taxes. For this very simple example, we are assuming Jill does not pay state or other income taxes. In this case, Jill’s net bonus pay would be 78% of $5,000, or $3,900.
In yet another example, Jill has had a really good year. No — really, really good. And you decide to pay her a $1.5 million bonus. The first million will be subject to that same 22% tax rate, which amounts to a $220,000 withholding, which reduces the bonus to $780,000 after taxes. The next half million will get hit with a 37% tax, further reducing the bonus to $405,000. That means Jill’s bonus check will need to be written for $1,185,000. Which, all things considered, is still a pretty nice payout.
Regardless of the bonus tax withholding method you use on supplemental wages, please keep in mind that bonuses are still subject to social security, Medicare, and FUTA taxes. Both methods of tax withholding require a little extra math, so we recommend using a payroll bonus calculator (try the one at the top of the page!) to make sure you’ve calculated everything correctly.
Our paycheck calculator at the top of this page includes state-specific data, but if you want to get more details about the numbers that go into our tax calculations, choose your state below:
Bonuses come in many shapes and sizes and can have a variety of use cases. Some employers offer cash bonuses to convince top job candidates to choose their company (and keep them away from a competitor). In other cases, businesses may decide to reward their entire staff with bonus pay around the holiday season. It usually comes down to what makes the most financial sense, the size of the team, a company’s culture, or whether the company even realizes that using bonuses to recruit (or retain) team members is a valuable tactic. Below, we cover some examples of common bonuses employers use to make a difference with their team members.
A profit-sharing bonus can take an employee’s contributions to your company up a notch. In most cases, an employee only receives this type of lucrative bonus when the business turns a profit.
Funds to reward employees are accumulated in different ways. For example, a business may set aside a portion of its profits each year to be distributed as profit-sharing bonuses. In other cases, the funds may be accumulated over time and invested in a separate account or pool.
In order to calculate the amount of money to award an employee through profit-sharing, many companies use a formula that takes into account such factors as the company’s overall financial performance and the length of an employee’s tenure. .
Why give this bonus?
Bonuses can be a great way to help an employee feel truly invested in a company’s goals and see themselves as part of the bigger picture as the organization grows.
Typically distributed towards the end of the year, holiday bonuses can be used to express gratitude and appreciation for an employee’s hard work. Depending on a company’s policy, the size of this bonus may vary or, in some cases, may be tied to an employee’s individual performance. In addition, paid time off (PTO) is also a type of bonus employers use to reward employees as the holiday season approaches.
Why give this bonus?
Almost all employees appreciate the gesture as they get ready for the holiday season, and it can also have a long-term positive impact on your company’s productivity, morale, and worker retention.
Employers sometimes offer a signing bonus to top candidates to encourage them to accept a job offer. Most of the time, this is a one-time payment made to the new employee (and presented by a company recruiter).
Why give this bonus?
In addition to keeping competitors at bay, it lets top recruits know you mean business and can be the difference-maker that entices them to accept your offer.
Many companies give employees a bonus for referring qualified job candidates to their human resources teams (which helps bring on new employees.)
Why give this bonus?
Between social channels such as LinkedIn or job review websites, there’s many ways for candidates to learn about working at your company. Your own employees can also be an excellent method to recruit talented new staff, especially when you provide financial incentive for employees to spread the word about job opportunities.
A financial reward based on the individual’s or team’s performance, often tied to specific goals or metrics.
Why give this bonus?
Most ambitious employees want to know they’re making a difference and getting the chance to meet (and even exceed) their goals. Knowing that they have a target to hit and one that they could potentially be rewarded for financially, is an incentive that will likely encourage them to go the extra mile in their role.
Some employers provide retention bonuses to encourage their best and brightest employees to stay with the company for a certain amount of time. Do you have employees, for example, who have been with you since opening the doors and have contributed to your company’s growth (or have stuck with you through thick and thin)? Or did you use a sign-on bonus to lure an amazing job candidate that you’re hoping to hold onto for the long haul? You may want to consider retention bonuses to let them know how much you appreciate the work they do.
Why give this bonus?
This bonus can keep top performers happy and productive, and it may prevent them from leaving over the long run.
Remember that bonuses can vary greatly from one employer to another, and depend on many variables including the size of an organization, the industry they’re in, and a company’s culture or goals.
When it comes to getting bonuses right, you can always use a little more information to be sure you’re on the right track. So, for some expert perspective (and closing thoughts), we spoke with CPA and professional tax advisor, Noel Lorenzana, of Lorenzana Tax & Accounting Services. Noel is a CPA with over 20 years of industry experience and we asked him to share some of the most common pitfalls that employers can easily avoid when calculating bonus pay.
The calculator at the top of this page is designed to help you figure out the correct amount of federal and state taxes to withhold when rewarding an employee with a well-earned bonus. That said, there can be other scenarios when getting paychecks right requires a little more wrangling. For example, when an employee departs, you may need to issue a final paycheck. Or if you offer tipped wages or bonuses, you may need to add another step or two to your gross pay formulas for hourly and salaried employees. you may find one of our other calculators below to be helpful down the road.
This bonus calculator and others included on this page are for informational purposes only and to provide general guidance and estimates; it should not be relied on for tax, legal, or accounting advice. If you are unsure about your obligations or need assistance, you should consult your own tax, legal, or accounting advisor for formal consultation.
Just share some basic information, then we’ll set everything up and import your employees’ information for you. It couldn’t be easier.
Bonuses are not a legal requirement for any business, but providing them to employees is a common practice for many employers. To help decide how much to reward team members, consider things like your company’s budget and its overall financial performance. In addition, you may find that a combination of cash bonuses and paid time off is a good mix to meet the needs of your employees.
Yes, you can offer a combination of different bonus types to meet the needs of your employees and company. You may want to think about the types of bonuses that align with your company culture, the values of your organization, and maybe even consider surveying your employees to find out what types of bonuses are most appealing to them.
Yes! We make it simple for employers to reward employees with a well-deserved bonus during a pay run. If you want to learn more, check out our resource on the 3-part pay run process in our help center.
To make sure all staff know about your company’s bonus policy, consider including details on your bonus policy in the employee handbook. You can also make it a point of discussion during new hire training.
You can also provide regular updates and communicate any changes to the policy through an organization-wide email, or via some form of an instant-messaging platform, if your company uses that type of communication.
Bonuses can be awarded at any time, but it is common to award them at the end of the year or on a specific date.
To get your retention bonus program started, consider offering bonuses for specific milestones or for staying with the company for a certain period of time. In addition, you can tie bonuses to performance or other criteria to ensure that only high-performing employees are eligible.
When offering bonuses to employees, it is important to be aware of federal and state labor laws, such as the Fair Labor Standards Act (FLSA), which sets standards for minimum wage and overtime pay. It’s also a good idea to be aware of any collective bargaining agreements that may apply to your employees and any applicable equal pay laws.
No, because the IRS considers bonuses to be income and classifies them as supplemental wages, this pay is subject to federal income tax withholding and may be subject to Medicare and Social Security taxes too. State and local taxes may also apply where you do business.