Hiring is picking up around the country, so companies may be feeling something they haven’t felt in a while—pressure to give year-end bonuses. While employees usually receive their bonuses in December,must begin planning for them now.
Tax talk. Bonuses are compensation and, therefore, fully taxable. If employees haven’t maxed out on the Social Security portion of FICA, the full FICA tax rate applies. If employees earn more than $200,000, withhold the employee Medicare tax at the 2.35% rate; the employer Medicare tax continues at the 1.45% rate.
How bonuses are paid and taxed is entirely up to you. You have three choices for income tax withholding.
• You can combine bonuses with employees’ regular pay and withhold on the total as if it was a regular wage payment
• Provided you withhold income taxes from employees’ regular pay sometime during the current or preceding year (i.e., they don’t claim an exemption from income tax withholding on their W-4s or a high number of allowances), you can pay bonuses in separate checks and withhold income taxes at the flat 25% rate
• You can skip withholding if the company grosses up (i.e., pays) employees’ taxes. To gross-up federal taxes, subtract the flat 25% income tax withholding rate and the full employee FICA tax rate from 1: amount of the bonus ÷ (1 – 0.25 – 0.0765) = grossed-up pay. You must also include the state tax rate in the denominator. If employees have maxed out on Social Security taxes, include only the appropriate Medicare rate (0.0145 or 0.0235) in the denominator.
High earners pay more. Bonuses are supplemental pay. Under a special income tax withholding rule, you must withhold a flat 39.6% on the amount of supplemental pay that exceeds $1 million. If a bonus will boost supplemental pay over $1 million, you may withhold 25% on the portion of the payment up to $1 million and 39.6% on the portion that exceeds $1 million, or you may withhold 39.6% on the entire payment.
Key: The IRS has confirmed that the 25%/39.6% rates are the only rates that apply to federal income tax withholding, so you may ignore employees’ requests to withhold at different rates.
DETAILS: You must also determine whether the bonuses will affect your federal and state tax deposit schedules.
Rule for federal tax deposits: 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.