Commercials for holiday gifts have been running on TV since at least Halloween. So naturally, employees are making their lists and checking them twice. Perhaps they’re counting on a holiday bonus to pay for it all. If holiday bonuses are in your future, be sure to cover these bases.
The Grinch who stole your bonus
Bonuses are always income and FICA taxable. Unless employees have maxed out on the Social Security portion of FICA, the full FICA tax rate applies. But how bonuses are paid and taxed—in separate checks or combined with regular pay in one check—is up to you.
Rule: Provided you withhold income taxes from employees’ regular pay, you may pay bonuses in separate checks and withhold income taxes at the flat 25% supplemental withholding rate.
Bonuses are supplemental pay. Under special income tax withholding rules that apply to employees whose total supplemental pay exceeds $1 million in a year, you must withhold a flat 35%, without regard to any W-4 form, on the portion of the supplemental pay that exceeds $1 million. Your choice: If the bonus boosts supplemental pay over $1 million, you may withhold 25% on the portion of the payment under $1 million and 35% on the portion that exceeds $1 million. Alternatively, you may withhold 35% on the entire payment. If the employee’s supplemental pay already exceeds $1 million, withhold a flat 35%.
If the company is giving employees, say, a $500 bonus, and wants that $500 to show up in their checks, it will have to pay employees’ taxes by grossing-up the bonuses. To gross-up, subtract the flat 25% income tax withholding rate and the employee FICA tax rate from 1:
Bonus amount ÷ (1 – 0.25 – 0.0565) = grossed-up pay.
If employees have maxed out on the Social Security wage base, include only the 0.0145 Medicare rate in the denominator.
Also, check whether the bonuses will affect your federal and state tax deposit schedules. Reminder: If you accumulate undeposited federal taxes of $100,000 on any day in a deposit period, deposit those taxes by the next banking day, regardless of your regular deposit schedule.
• STATE WITHHOLDING RATES: The gross-up formula doesn’t reflect state income taxes, which must also be included in the denominator. See "State chart: withholding on supplemental pay."