Why Is Your Bonus Taxed at a Higher Rate?
“It’s not fair, every time I get a bonus the IRS taxes it like crazy. Why are my bonuses taxed at a higher rate?”
Does this sound familiar? Have you ever felt short-changed when you got a bonus just to realize almost half of it is taken away for taxes? Here’s why you don’t need to worry(much).
Contrary to what you may hear from co-workers, bonuses are not taxed at a rate higher than your ordinary income. The amount of income taxes you pay on your earnings will always be based on how much money you earn through the entire year and whether some of that money is earned as a bonus or not has no effect on your total taxes.
You will notice that the amount of taxes withheld from a bonus is unusually high. This happens simply because of the way withholding calculations work. If you’ve claimed the proper amount of allowances on your W-4, your withholding will automatically be adjusted throughout the year to take out exactly the right amount of taxes based on your total income and anticipated deductions and credits. When you receive a bonus, for purposes of your withholding calculations, it appears that you’re earning substantially more income for the year and will therefore need to pay more in total taxes.
Here’s an example:
Let’s say you earn $1,000 per week. That’s $52,000 per year. For a single person taking the standard deduction, that would mean an annual federal tax bill of $6, 139. As long as you are being paid $1,000 per week, you’ll have $118.05 automatically withheld each week which works out to roughly $6,139 through the course of a year, or the exact amount to cover all of your taxes. Simple enough!
Now let’s say the first week of the year you get paid a $1,000 bonus in addition to your regular $1,000 salary. When your withholding is calculated in this situation, it appears as if you’re earning $2,000 per week for an annual income of $104,000! With that kind of income you would need to pay over $19,000 in taxes, so in order to cover that huge tax bill, the withholding calculation results in $369 being taken from your check. If you do end up earning only the $52,000 through the year however, your withholding calculations would take into account that extra withholding from the bonus check at the start of the year. Your withholding will automatically adjust to take out slightly less through the rest of the year so that no more than the necessary $6,319 is withheld.
In the end you will pay taxes based on your total earnings for the year regardless of how much was withheld from a bonus. If for some reason too much money is actually taken from a bonus, you still don’t lead to worry, you will get it back as a tax refund.
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