How Are Bonuses Taxed?

Whether it’s expected or unanticipated, receiving some extra cash and recognition from your employer in the form of a bonus is always appreciated. But it’s important to remember that, as with all income, the IRS will want its fair share of your windfall, which means the amount you’re told you will receive will almost certainly never match the actual amount that ends up in your pocket.  

Further complicating the matter is that a bonus is considered to be a form of “supplemental wages,” which means it's subject to its own tax withholding rules. So it’s understandable if you’re not entirely sure how bonuses are taxed and how those taxes are withheld. Here’s what you need to know. 

What are supplemental wages? 

Supplemental wages are any form of payment that you receive as an employee other than your normal salary or wage. In addition to bonuses, this category includes overtime, tips, commissions, accumulated sick time, prizes or other awards.  

Why does this matter? Because supplemental wages are subject to their own tax withholding rules that are different from other forms of income.  

How are bonuses taxed?   

Bonuses are taxed differently from regular pay: They’re taxed at ordinary income tax rates. Below, we’ll get into some of the specifics on different ways a bonus can be taxed.  

What is the bonus tax withholding rate?  

Taxes for supplemental wages, including your bonus, can be withheld in two different ways. One is by applying a flat withholding percentage rate of 22 percent, the other is a percentage that changes based on the amount of your pay and bonus. Here’s how each works: 

The percentage method 

If your employer pays you your bonus separately from your regular pay, then it will likely employ the percentage method.  

This means that it will simply withhold the flat rate as required by the IRS. In 2023, this would be 22 percent for most people receiving a bonus (and 37 percent for any amount above $1 million). This means that if you receive: 

• A bonus that is up to $1 million, your employer may withhold 22 percent of your bonus for federal income taxes. 

• If the sum of any bonuses you receive totals more than $1 million, your employer must withhold 22 percent on the first million, and then 37 percent on anything above that first million, for federal income taxes.  

This flat withholding rate is the source of a lot of confusion. After all, if your marginal tax rate is normally lower than 22 percent, then it may seem that you are actually paying additional tax on your bonus.  

But when you file your taxes at the end of the year, your bonus is ultimately treated just like the rest of your income. So if you received a bonus and still fall into a tax bracket that is lower than 22 percent, you’ll receive a refund equal to the excess amount that was withheld. 

However, if it turns out that you fall into a higher tax bracket, you’ll have to make up the difference between the 22 percent that was withheld and your final tax rate.  

Pros and cons of the percentage method 

The nice thing about the percentage method is that it’s easy for your employer to apply and easy for you to calculate. The downside is: Not everyone is in a tax bracket that taxes at 22 percent. If your income tax rate is lower than 22 percent, you could be getting more withheld at a higher rate than your actual tax rate, and if you’re in a higher tax bracket, you may not be withholding enough with this method.  

The aggregate method 

If your employer pays you your bonus in the same check as your regular pay, then it will employ the aggregate method. This is much more complicated compared to the percentage method, as it requires your employer to consider both your regular wages and your bonus. It’s also confusing because of the way federal taxes work.  

Basically, as you earn more, you pay additional income tax. With the aggregate method, your company adds the amount of your bonus and base pay. It then assumes you’ll get that higher amount all year and withholds based on that amount.  

For example, if you normally earn $4,000 per month, or $48,000 per year, and you are a single tax filer, this would place you in the 22 percent tax bracket.  

If you were to receive a $10,000 bonus one month and your employer uses the aggregate method to determine your withholdings, they would: 

1. Add the bonus to your base pay: $10,000 bonus + $4,000 base pay = $14,000 

2. Multiple this total by your total pay periods in a year: $14,000 x 12 months = $168,000 

3. Use your filed W4 to determine your tax bracket: In this case, it’d be 34 percent 

4. Subtract from this amount any taxes already withheld from your paycheck 

The remainder would then be withheld from your bonus for that payroll period.  

Pros and cons of the aggregate method 

The aggregate method is much more complicated for your employer to figure out, however because of these added calculations, there’s a better chance that you’ll withhold closer to what you actually owe. However, there still is the chance you may withhold too much or too little, which you’d need to reconcile come tax time.  

Additional taxes 

In addition to the federal tax rate mentioned above, it’s important to remember that your bonus will be subject to other taxes as well. This includes state income taxes (if your state levies one), Social Security and Medicare taxes.  

State income taxes 

Depending on where you live, you may have to pay state taxes to pay on your bonus. Some states apply an added percentage, usually somewhere between 5 to 7 percent. Other states vary the percentage (anywhere between 2 to 5 percent) depending on your gross salary amount. And some states don’t charge supplemental income taxes at all. If you’re curious about regulations in your state, check with your state’s department of revenue.  

How bonuses are taxed for Social Security 

Social Security tax comes out of all of your wages—including your bonus. So as with your regular paycheck, 6.2 percent of your bonus will go toward Social Security. This rate is in addition to the 22 percent (or aggregate percentage). (If you make over $160,200, however, you’ll only have to pay Social Security tax on up to $160,200 of your income in 2023.) 

How bonuses are taxed for Medicare 

Similar to Social Security, your Medicare tax is consistently withdrawn from all of your income, including your regular wages and your bonus. 1.45 percent of your bonus, therefore, will go toward Medicare. And like with Social Security, this is also added onto 22 percent (or aggregate percentage) withheld from your bonus.  

Lowering your tax burden 

While the IRS is going to get its fair share of your bonus, you may be able to employ certain strategies to lower your overall tax burden. 

Contributing to a tax advantaged account 

You may be able to reduce your taxable income for the year by putting funds into a 401(k), IRA or HSA. Depending on your income, this may put you into a lower tax bracket and reduce the percentage you’ll pay on your income.  

Bonus deferral 

Consider Asking your employer to defer your bonus to the following year to move your tax obligation on those funds into the next year. This strategy may benefit you if you think you may make less money in the coming year. It’s important to keep in mind, however, deferred bonuses must be unfunded and unsecured. So, if your employer cannot pay the bonus in the next year, you may end up losing your bonus.  

Itemizing deductions 

Choosing to spend your bonus on certain expenses could also lower your tax liability. While most people take the standard deduction, if you’re able to spend more money on tax-deductible expenses, you may find that itemizing savings you more. Out-of-pocket medical expenses not covered by insurance, mortgage interest and charitable donations are some common deductions taxpayers are eligible to itemize.  

What should you do with your bonus? 

If you’ve already received a bonus or anticipate receiving one and are unsure how the bonus will impact your tax burden for the year, a Northwestern Mutual financial advisor can help you understand your options. In addition to helping you lower your tax burden by deploying some of the strategies outlined above, they can also help you put your bonus to good use as you work toward your financial goals. 

Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.