Bonus Tax Withholding

Bonus tax withholding is the amount of federal income tax an employer removes from a bonus before paying it out. The IRS classifies a bonus as a supplemental wage, a category that also includes commissions, overtime, and severance, and it lets employers withhold on supplemental wages in one of two ways. The most common is the flat-rate method: a single 22% is withheld, applied without regard to the employee's Form W-4. The key point that confuses many people is that this 22% is withholding, a prepayment toward the year's tax, not a special tax on bonuses. The bonus is ultimately taxed at the same ordinary income rates as the rest of a person's income, and the difference between what was withheld and what is owed is settled on the tax return.

Employers have two methods. Under the flat-rate method, when a bonus is paid separately or separately identified, the employer withholds a flat 22% of it, set by IRS Publication 15 and applied "without regard to any entries on the Form W-4." Under the aggregate method, the employer lumps the bonus in with a regular paycheck and withholds as if the combined amount were the employee's normal pay, which usually pulls a larger amount because it treats a one-time bonus as if it recurred every pay period. Which method an employer uses is the employer's choice, and it explains why two people with identical bonuses can see very different amounts withheld.

The 22% flat rate is a rough estimate, and its roughness is the practical problem. For an employee whose top marginal rate is 22% or below, it is close to right. For a higher earner whose bonus stacks on top of income already taxed at 24%, 32%, 35%, or 37%, the 22% withholding is too low, and the shortfall shows up as a smaller refund or a balance due at filing. This is the same mechanism that catches employees whose restricted stock units are withheld at a flat rate, a problem covered under RSU tax withholding. It is the mirror image of the popular complaint that a bonus is "taxed to death": the large chunk taken looks like a penalty, but if anything the flat rate often under-withholds for the people most likely to complain.

A separate, fixed rule applies to very large amounts. When an employee's supplemental wages exceed $1,000,000 in a calendar year, the portion above $1,000,000 must be withheld at the highest income tax rate under the tax code, currently 37%. That $1,000,000 threshold is a fixed statutory figure and is not adjusted for inflation, and the 37% is a cross-reference to the top bracket rather than a separate bonus rate, so it moves only if the top bracket itself changes. Bonuses are also subject to Social Security and Medicare (FICA) taxes like any wages. This entry covers the withholding on a bonus; the broader supplemental-wage rules that reach commissions, severance, and other irregular pay are covered under supplemental wage withholding.

Withholding on a bonus is a prepayment, and the true-up happens on the return.

If the employer uses the flat method, it multiplies the bonus by 22% and sends that to the IRS. If it uses the aggregate method, it combines the bonus with a paycheck and withholds on the total as though that were the normal wage. Either way, the amount withheld is credited against the year's total tax, and the bonus itself is taxed at the person's ordinary marginal rates.

A hypothetical example shows the gap for a higher earner. Suppose Marcus receives a $10,000 bonus and his employer uses the flat method, withholding 22%, or $2,200. Marcus's other income already puts his next dollars in the 32% bracket, so the $10,000 bonus actually adds about $3,200 to his federal income tax. Because only $2,200 was withheld, he will owe roughly $1,000 more when he files ($3,200 minus $2,200). Nothing was taxed at a special rate; the bonus was simply under-withheld relative to his real bracket. If Marcus's top rate had been 22% instead, the flat withholding would have been about right and he would owe little or nothing extra on it.

Pros

• The flat 22% method is simple and predictable, so employees can see exactly what was held back.
• Withholding is only a prepayment, so any excess comes back as a refund and nothing is truly "lost" to a special bonus tax.
• For employees taxed at 22% or below, the flat rate is close to the correct amount.

Cons

• For higher earners, the flat 22% under-withholds, producing an unexpected balance due at filing.
• The two methods can withhold very different amounts, so the take-home on an identical bonus varies by employer choice.
• The large amount withheld can feel like a penalty, fueling the myth that bonuses are taxed at a higher rate.