While you might think, logically, that employees could be better served tax-wise by gradual bonuses paid over a series of paychecks or by a simple raise that tacks on some extra money year-round, Greene-Lewis says that a company's ability to pay bonuses is determined between the time it finishes up its accounting for the year and when it officially closes its books.
In some cases, those bonuses have to be paid before that year is closed. Because a company doesn't know how much it can afford to pay until the last possible minute, employees end up getting lump sums. Disclosure: This post may highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy.
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And as is the case with other income from an employer, the employer is required to withhold taxes from a bonus, reducing your take-home pay from the windfall.
A financial advisor can help you optimize a tax strategy for your bonus and invest that money in your retirement and other financial goals. Most major employers award some type of bonuses, according to a September survey of large employers by Willis Towers Watson. Next year, about two out of three big employers plan to award annual performance bonuses, and nearly that many will keep the size of the bonus pool the same as this year, according to the survey.
First, you can reduce your gross income. Second, you can increase the deductions that apply to your income. One of the most effective ways to reduce taxes on a bonus is to reduce your gross income with a contribution to a tax-deferred retirement account. Terms apply to offers listed on this page. Read our editorial standards. What I do remember, however, is how surprised I was to see how much less I received than the number I was told at my end-of-year review. Thanks, taxes.
I know I'm not the only one mystified by the case of the missing bonus, so I reached out to Certified Public Accountant Lisa Greene-Lewis of TurboTax to find out why end-of-year bonuses seem to be taxed at such a high rate.
It comes down to what's called "supplemental income. It's probably that withholding you're noticing on a shrunken bonus check. Employers take taxes from your check in one of two ways:. The percentage method. This is the method your employer will use if, like I did, you receive your bonus money in a check separate from your paycheck. The aggregate method. When you file your tax return, your tax rate may rise a bit to 16 or 17 percent, but not the full 25 percent that you were taxed during the one paycheck with a bonus added to it.
So, the extra amount that was withheld back in July gets refunded to you when you file your return. Is there any way around it? If you are married with two children, you would normally claim Married and 2, but if you want a lower amount of taxes withheld you could claim Married and 8, instead.
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