How Are Bonuses Taxed?

Matt Boyd is an assistant director of High-Net-Worth Tax Planning at Northwestern Mutual.

Whether it’s expected or not, receiving some extra cash and recognition from your employer in the form of a bonus is always appreciated. But it’s important to remember that, as with all income, the IRS will want its fair share of your windfall. This means the amount you’re told you will receive will not match the actual amount that ends up in your bank account.

Further complicating the matter is that a bonus is considered “supplemental wages,” which means it's subject to its own tax withholding rules. So, it’s understandable if you’re not entirely sure how bonuses are taxed and how those taxes are withheld. Here’s what you need to know.

What are supplemental wages?

Supplemental wages are any form of payment that you receive as an employee other than your base salary or wage. In addition to bonuses, this category includes equity compensation (like stock options), overtime, tips, commissions, accumulated sick time, and prizes or other awards.

Why does this matter? Supplemental wages are subject to their own tax withholding rules that are different from the withholding rules for your base wages.

But not everything counts as a bonus. You won’t owe tax on small perks like coffees or snacks, occasional tickets to entertainment events, or meals. These are known as “de minimis fringe benefits”—because of the low value and frequency with which these items are provided, the IRS considers it unreasonable or impractical to account for such items, and they are therefore nontaxable.

What is the bonus tax withholding rate?

Many companies tie a portion of employees’ pay to individual and/or company performance by offering a cash bonus in addition to (or in lieu of) a pay raise. A bonus can be a nice one-time infusion of cash. At the end of the year, your bonus is included on your W-2 and taxed just like the rest of your wages. However, when your company pays the bonus, it withholds taxes, and that withholding isn’t always as straightforward as you might think.

Taxes for supplemental wages, including your bonus, can be withheld in two different ways. One is by applying a flat withholding percentage rate of 22 percent (or 37 percent); the other is a percentage that changes based on the amount of your pay and bonus. Here’s how each works:

The flat percentage method

If your employer pays you your bonus separately from your regular pay, then it will likely employ the flat percentage method.

This means that it will withhold at a flat rate as required by the IRS. The rate is 22 percent for supplemental wages up to $1 million, or 37 percent if (or when) your accumulated supplemental wages from that employer, for that year, exceed $1 million. This means that if you receive:

1. A bonus that is up to $1 million, your employer may withhold 22 percent of your bonus for federal income taxes.

1. A sum of any bonuses (or other supplemental wages) that totals more than $1 million, your employer must withhold 22 percent on the first million and then 37 percent on anything above the first million.

This flat withholding rate is the source of a lot of confusion. After all, if your average tax rate is normally lower than 22 percent, then it may seem that you are paying additional tax on your bonus. But when you file your taxes at the end of the year, your bonus is ultimately treated just like the rest of your wages. So, if you received a bonus and still have an average tax rate that is lower than 22 percent, you’ll receive a refund equal to the excess amount that was withheld.

However, if it turns out that you fall into a higher tax bracket, you’ll have to make up the difference between the 22 percent that was withheld and your final average tax rate. This tends to impact highly compensated executives or individuals with significant income from other sources, like from a spouse or a business. Those individuals need to consider additional tax payments to avoid a tax return balance due and potential late payment penalties and interest.

Pros and cons of the percentage method

The nice thing about the percentage method is that it’s easy for your employer to apply and easy for you to calculate. The downside is most people will not have an average tax rate of 22 percent. If your income tax rate is lower than 22 percent, more is being withheld than necessary. If your income tax rate is higher than 22 percent, you may not be withholding enough tax with this method.

The aggregate method

If your employer pays you your bonus in the same check as your regular pay, then it will employ the aggregate method. This is more complicated compared to the percentage method, as it requires your employer to consider both your regular wages and your bonus. It’s also confusing because of the way federal taxes work.

Basically, as you earn more, you pay additional income tax. With the aggregate method, your company adds the amount of your bonus and base pay. It then assumes you’ll get that higher amount all year and withholds based on that amount.

For example, if you are single and normally earn $48,000 per year, and you are paid monthly ($4,000 per pay period), you would use the current year IRS payroll tables (Publication 15-T) to determine the withholding amount for those circumstances. Subject to the elections made on Form W-4, this would result in a withholding rate of about 7.8 percent.

If you were to receive a $10,000 bonus one month, and your employer uses the aggregate method to determine your withholdings, they would:

• Add the bonus to your base monthly pay—$10,000 bonus + $4,000 base pay = $14,000.
• Use your filed W4 to determine which payroll table to apply to determine withholding on this higher amount and then calculate the withholding amount: Applying the same table as above, the withholding rate would be about 17.6% on a $14,000 monthly payroll.
• Subtract from this amount any taxes already withheld from your paycheck on base pay to determine the withholding related to the bonus.

The remainder would then be withheld from your bonus for that payroll period.

Pros and cons of the aggregate method

The aggregate method is more complicated for your employer to compute; however, because of these added calculations, it is likely that the amount withheld will be closer to what you actually owe. But there still is the chance you may withhold too much or too little, which you’d need to reconcile on your tax return. It is less common for employers to use this withholding method, and the withholding method is at the discretion of the employer.

Additional taxes

In addition to the federal tax rate mentioned above, it’s important to remember that your bonus will be subject to other taxes as well. This includes state income taxes (if your state levies one), Social Security and Medicare taxes.

State income taxes

Depending on where you live, you may have to pay state taxes on your bonus. Some states have a supplemental wage withholding rate, while other states treat the bonus the same as other wages. Because state taxes have a smaller range of potential rates than federal taxes, bonus withholding does not tend to cause significant over-withholding or under-withholding of state tax. If you’re curious about bonus withholding rules in your state, check with your state’s department of revenue.

How bonuses are taxed for Social Security

Social Security tax comes out of all of your wages—including your bonus. So, as with your regular paycheck, 6.2 percent of your bonus will go toward Social Security. This rate is in addition to the 22 percent (or aggregate percentage). Social Security tax is assessed only on the first $176,100 of wages in 2025, so you may not owe this tax if/when your aggregate wages for the year exceed this threshold.

How bonuses are taxed for Medicare

Similar to Social Security, your Medicare tax is withheld from all of your wages, including your base wages and any bonus. That means 1.45 percent of your bonus will go toward Medicare. And as with Social Security, this is also added to the 22 percent (or aggregate percentage) withheld from your bonus.

How to minimize taxes on bonuses

While the IRS is going to get its share of your bonus, you may be able to employ certain strategies to lower your overall tax burden.

Contributing to tax-advantaged accounts

When you have extra money, you may be able to put more toward things like your retirement. For example, you can reduce your taxable income for the year by contributing funds to a 401(k), IRA or HSA. Depending on your income, these contributions may move you into a lower tax bracket and reduce the percentage of your income that you’ll have to pay in federal tax. It’s important to remember, however, that these accounts all have contribution limits that may not change based on getting something like a bonus.

Bonus deferral

Consider asking your employer to defer your bonus to the following year to move your tax obligation on those funds into the next year. This strategy may benefit you if you think you may make less money in the coming year. It’s important to keep in mind that deferred bonuses must be unfunded and unsecured. So, if your employer cannot pay the bonus in the next year, you may end up losing your bonus.

Itemizing deductions

Choosing to spend your bonus on certain expenses could also lower your tax liability. While most people take the standard deduction, if you’re able to spend more money on tax-deductible expenses, you may find that itemizing saves you more. Mortgage interest and charitable donations are the most common itemized deductions.

What should you do with your bonus?

If you’ve already received a bonus or anticipate receiving one and are unsure how the bonus will impact your tax burden for the year, your Northwestern Mutual financial advisor can help you understand your options. In addition to helping you lower your tax burden by deploying some of the strategies outlined above, they can also help you put your bonus to good use as you work toward your financial goals.

Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.