To reward you for excellent service, your employer might give you bonuses, which are also called supplemental wages, as they are not regular income. Bonuses are subject to federal and, in some cases, state income tax. The amount of federal income tax that’s taken out of your bonus depends on whether it’s paid with regular wages or separately. State income tax withholding rules vary by jurisdiction.
To figure the percentage of federal income tax that should come out of your bonus, go online and get a copy of Internal Revenue Service Circular E for the tax year that the bonus is issued. The 2012 version says that if the payment is issued on separate check from your regular wages, a flat 25 percent applies. For example, you earn a salary of $1,250 biweekly and receive a monthly bonus of $500. Your regular salary would be taxed as normal. The bonus check would be taxed at $125 ($500x0.25).
If the bonus is paid with your regular wages, it should be taxed as a single payment for the pay period. For example, add your salary of $1,250 to the bonus amount of $500, which equals $1,750. Assume that you claim married filing status and two allowances on your W-4 form. Find the Circular E tax table that matches the W-4 information plus your pay period and earnings. According to Page 45 of the 2012 Circular E, you would pay $138 in federal income tax.
Each state has its own requirements for withholding state income tax from bonus checks. For example, Colorado requires a flat 4.63 percent withholding, but Arizona doesn’t have a flat rate rule. In the latter case, employers withhold state income tax via the aggregate method, which requires them to deduct the tax at the regular withholding rate. In Arizona, employers withhold state income tax based on the percentage employees elect on their A-4 form.
If you’re lucky enough to have an employer that’s willing to absorb your tax liabilities so you receive the full bonus amount, your employer must "gross-up" the bonus. Your employer pays the taxes, but it’s included in your gross wages and appears on your pay stub as though you paid them. To figure gross-up, first calculate the total percentage of all taxes due including Medicare and Social Security taxes; see the Circular E for these tax rates. Include state income tax if it applies. Convert the percentages of taxes due to decimals and tally them. Subtract the total tax amount from 1.0000. Divide the agreed-upon bonus amount by the total tax amount to arrive at the bonus gross-up amount.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.