GBE Clients,
When we hear this question, we believe what people really want to know is: Why do employers withhold so much on bonus pay?
Bonus Tax
Bonuses are taxed the same as regular pay. They are listed (along with all of your job income for the year) on Form W-2 and are a part of your annual tax filing. There is nothing special about bonuses at tax time.
Bonus Withholdings
Most employers withhold on bonus pay by applying a flat 22% tax rate to the bonus amount (plus waterfalls for amounts of $50,000 or more).
Alternatively, employers may calculate the withholding percentage based on the combined amount of your bonus and regular paycheck (adjusted according to income level).
In either case, this bonus withholding is generally larger than your effective tax rate. Meaning: This practice often leads to a refund at tax time.
My Friend Said to Change My W-4 for the Bonus
This is a dangerous practice at best. Yes, it is true you are allowed to change your W-4 to ensure less withholdings on your bonus pay. However, the ramifications of such a change may be unknown until tax filing time. Generally, it is better to leave your W-4 alone and have the extra withholdings.
Positives of Extra Withholdings
Avoiding Underpayment Penalties: Your tax withholding obligations will likely be met, reducing the risk of penalties.
Receiving a Refund: Extra withholding may result in a satisfying tax refund.
Forced Savings: This acts as a form of forced savings, as the extra money withheld is saved for you until tax refund time.
Negatives of Extra Withholdings
Less immediate take-home pay
Government holds the money until your tax refund is received
Takeaways
Tax withholdings on your bonus paycheck may feel painful. However, instead of changing your W-4:
Try understanding how this bonus may affect your tax refund and plan accordingly
Consider saving some extra money into your investment accounts at bonus time
Review your W-4 on an annual basis (or upon significant life changes) rather than making risky changes at bonus time
For specific questions, please contact your GBE advisor!