Where Does Your Holiday Bonus Go?

The year is winding down, and for some, that means holiday bonuses. Ideas of extravagant purchases, future vacations or even extra padding in a savings account abound. But once your bonus is deposited, you might notice it’s smaller than you expected – much smaller. That’s because bonuses are actually taxed at a higher tax percentage than your normal paycheck.

But why?

Bonuses are considered “supplemental income.” This means any money you make that’s outside your normal wages. While your earned dollars are equal at tax time, once a bonus is issued this description is slapped on and the IRS holds it at a much higher withholding rate. There are two ways your employee withholds the necessary payroll taxes from your check (and yes, we have a calculator for both):

Aggregate Method: This method is based on an employee’s W-4, and used when your bonus is dispensed along with a standard paycheck. Employers withhold tax from your bonus plus your regular earnings according to your W-4. You’re receiving more money, so you’re getting taxed at a higher rate, too.

Percentage Method: If your employer plans to deliver your bonus separately from your regular paycheck, they’ll tax it at a flat 22% rate. For payroll departments, this is the easier route to take.

Despite being subject to a higher tax, bonuses are considered a great thing. It means your company is healthy financially and your bosses value you. And even with the added taxation, a little extra cash never hurt!