It's nice getting a year-end bonus from your company. It feels like a great Christmas present. You're jumping for joy, dancing around like a kid, then wham! You see your payment statement and it's nowhere close to the amount you were told. You start thinking, someone made a mistake. The statement shows the correct amount, but there must be something wrong with the tax withholdings. It's too high!?! Not really. Here's the explanation.
The statutory federal withholdings for a bonus is 25 percent. On top of this, you need to add other taxes such as state income taxes, Social Security taxes and various taxes for state and federally mandated insurance programs. Overall, the average total tax withheld comes out to around 40 percent. So if your bonus was $1,000, then the tax withheld would be about $400 and you would only get $600. The exact amount will depend on your specific situation, such as how many dependents you've declared. Altogether, according to the IRS, you can expect to lose about 20 percent of your bonus overall to taxes.
The withholding shock is often not permanent. For year-end tax purposes, the bonus is simply considered a part of your salary. For example, if you normally make $50,000 per year, your total gross income would be $51,000. So, when you file your tax returns, your total income for the year is $51,000 and you will receive refunds based on that amount.
Another question you might have regarding a company bonus is whether the employee can choose to not withhold such a large portion. The answer is no. The company is required to take the taxes out. However, whatever is taken out in withholding on your bonus will help to pay off your ultimate tax bill. In effect, this means that many people who receive significant bonuses also end up receiving large tax refunds once the tax season is complete.