Bonuses are more than just financial incentives; they’re a strategic tool for rewarding performance, boosting morale, and aligning your team’s efforts with your organization’s goals.
But while the excitement over bonuses is real, the tax side can be confusing — for both you and your employees.
In this in‑depth guide, we’ll break down everything you need to know about bonus tax rates, including federal rules, state nuances, payroll tax implications, and communicating with your employees. So let’s jump straight in.
Are bonuses taxed in the US?
Yes. Bonuses are classed as income and, as such, are subject to tax.
However, the Internal Revenue Service (IRS) classifies bonuses as supplemental wages (alongside other non-regular wages, such as commissions or severance pay). As they're not part of your employee’s “regular” paycheck, they are taxed in one of the following two ways:
- Flat (percentage) method
- Aggregate method
Which option your company chooses affects how much your employees actually take home — and how smoothly your payroll process runs.
The two methods work as follows:
1. The flat (percentage) method
The flat method is the go‑to for many businesses because of its simplicity. It involves a flat federal rate of 22%, applicable on bonuses up to $1,000,000 in a calendar year.
For example, if you award an employee an annual bonus of $25,000, you will need to withhold $5,500 of that for tax ($25,000 x 22%).
For bonuses above $1 million, though, the rate jumps to a much steeper 37%.
For instance, let’s say you award a $1.5 million bonus. The first million is withheld at 22% ($220,000), and the remaining $500,000 is taxed at 37% ($185,000), for a total withholding of $405,000.
This option is generally favored in payroll systems because it avoids shifting withholding brackets mid‑paycheck. Employees may end up over‑ or under‑withheld compared to their true annual tax bracket, but those adjustments happen at tax‑filing time.
2. The aggregate method
Under the aggregate method, bonuses are treated as additional salary. The bonus gets added to the employee’s regular paycheck, and the combined total is taxed based on the employee’s regular withholding rate (determined by their W‑4).
However, because the IRS expects that paycheck to be typical, the taxable income may land in a higher bracket — leading to a larger withholding amount on that paycheck .
For example, let’s say that you pay an employee $6,000 per month. One month, you give the employee a bonus of $10,000, resulting in a total monthly paycheck of $16,000. The IRS may assume that that monthly payment of $16,000 is “typical,” and estimate the employee’s annual income as $192,000 ($16,000 x 12 months). This would potentially trigger a 32% withholding rate, even though the employee’s actual average rate is around 22%.
As a result, this method can leave employees with less take‑home and more unpredictability, even though any under- or over‑withholding will be reconciled at year‑end.
See also: Gifts vs bonuses: What are the tax consequences?
What about payroll taxes?
In addition to the above, bonuses are subject to Social Security and Medicare taxes, just like regular wages. This includes:
- Social Security: 6.2%
- Medicare: 1.45% (plus 0.9% for earnings over a set threshold)
No separate or special payroll tax rates apply to supplemental wages.
What about state and local taxes?
While the IRS’ federal rules apply nationwide, some state and local tax schemes differ — dramatically, in certain cases. Keep in mind that:
- Some states impose flat withholding rates for bonuses. In California, for instance, supplemental wages are taxed at a flat rate of 10.23%.
- Other states may defer to your employee’s bracket-based schedule, meaning bonuses may be taxed just like regular wages (or using an aggregate method).
- A few states impose no income tax on bonuses.
If you operate across state lines, you’ll need to implement different withholding methods for each jurisdiction. This is why it’s advisable to work with a payroll partner that can seamlessly ensure compliance across multiple states, rather than just one locale.
See also: What you should know about giving bonus payments to contractors
Communicating bonus taxes with your employees
As mentioned, bonus tax rates can be confusing for both employers and employees. This is especially true for employees who are over-withheld, which can be demoralizing and frustrating.
Therefore, it’s important to communicate clearly with your people how their bonuses will be taxed. As part of this, ensure you clarify that all withholding is essentially an estimate — not a final tax bill. The employee’s actual liability is determined when they file their annual return, considering their:
- True annual income
- Deductions (such as mortgage interest, charitable contributions, etc.)
- Filing status, credits, and more
Always clarify to your employees that their bonus withholding (especially the flat percentage) isn’t their final tax cost. They should expect a refund or additional taxes owed after filing, depending on their personal financial situation.
Best practices for managing bonus tax rates
From a tax perspective, there are a few things you can do to help your employees when handing out bonuses. For instance, it’s generally advisable to:
- Choose a consistent withholding approach. There are pros and cons to each approach, but whatever you choose, be consistent.
- Keep track of Social Security caps. If you give an employee a bonus that could push them over the $176,100 Social Security cap threshold, you may reduce their net benefit.
- Verify state and local rules. Ensure that you apply flat or bracket-based withholding based on each jurisdiction.
- Communicate clearly with your employees. As mentioned, outline how their bonus will be taxed, and emphasize that final liability depends on their full-year income.
- Provide resources. Encourage tax planning, W‑4 adjustments, or contributions to retirement vehicles (like 401(k)s, IRAs, or HSAs). This can help your employees reduce their taxable income and improve their take-home value.
How can Remote help?
Remember, bonuses are supplemental wages subject to special withholding rules (flat rate or aggregate). You must also withhold payroll taxes (Social Security and Medicare), while state and local rules can vary depending on where your people are based.
As a result, managing everything — and ensuring you adhere to all the correct rates and rules — can quickly become complex, especially if you have employees in multiple states (or even other countries). Our world-class, centralized Payroll service takes care of all this for you, giving you complete peace of mind and helping to ensure you are fully compliant at all times.
To learn more about how we can remove all your payroll and compensation headaches — including bonuses — speak to one of our friendly experts today.