Why Your End-of-Year Bonus Isn’t As Big As You Think

Published

November 21, 2013

Bev O'Shea lives and works in the foothills of the Appalachians. A former editor of MSN's Smart Spending blog, she's a fan of sunsets, college football and free shipping.

We’re nearing the time of year when many businesses distribute end-of-year bonuses to high-performing employees (or holiday bonuses to all). And the number you hear from your boss is likely to be bigger than the one you see on your paycheck. Blame the difference on tax withholding.

Unless your bonus is $1 million or so, your employer is required to withhold at least 25% of the total bonus for federal taxes. And if your bonus is less than $1 million, take heart; the really high rollers have even more withheld from theirs. (Other taxes, like state taxes and Social Security, will be withheld as well.)

Employers have a choice of withholding 25% or using what is called the “aggregate method,” according to TurboTax. Let’s say you’re getting a bonus of $10,000. Your employer might choose to withhold $2,500 for federal taxes, but that’s not required. The alternative is to add the bonus to your regular paycheck (let’s say that’s $2,000), and then withhold from the combined total the federally mandated tax rate (as if your regular paychecks were $12,000 apiece).

It’s possible for a bonus to push your income into a higher tax bracket. If you are concerned about that, you could ask your employer to wait until January to give you your bonus, pushing the income — and tax obligation — into 2014.

The amount withheld from your bonus is unlikely to match your tax obligation exactly. The amount you owe in taxes will depend on your individual circumstances, and the amount withheld from your bonus check, or the way it was calculated, will not affect it.

Image: Pogonici