Employers must record the value of cash bonuses paid to employees in the payroll system and report the amounts on the employee’s annual Form W-2 Wage and Tax statement. Because you did not withhold taxes from the payment, you also need to “gross-up” the value of bonus, meaning the employer will pay both the employee and employer withholding tax amounts to the government.
Things You'll Need
- State withholding rates
- Payroll software
Sum the percentages of all taxes that should have been withheld from the bonus. These include 25 percent for federal income tax withholding (FIT), 6.2 percent for Social Security tax, 1.45 percent for Medicare tax, the supplemental tax percentage for state income tax (SIT) and any local or state disability (SDI) taxes. State income tax supplemental rates vary by state. For example, if the employee works in California the calculation would be 25 percent + 6.2 percent + 1.45 percent + 10.23 percent +1.1 percent = 43.98 percent.
Subtract the result from 100 percent. For the California example this would be 100 percent - 43.98 percent = 56.02 percent.
Divide the amount of the cash bonus by the result from Step 2. Let’s say you paid a cash bonus of $500: $500/56.02% = $892.54. This is the gross amount of the bonus you need to record in your payroll system.
Enter the gross bonus amount and the required withholding taxes into your payroll system. For this example, you would enter $892.54 gross bonus, $223.13 FIT, $55.34 social security tax, $12.94 Medicare, $91.31 SIT $9.82 SDI and $500 net pay. Notice that the net pay amount equals the cash the employee received. As you can see, in this example paying a cash bonus will cost the employer an additional $392.54 in order to cover the employee’s share of withholding tax, making the actual cost of this $500 award $892.54.
Process your payroll as normal. The employer share of taxes will calculate with your payroll processing, and since you’ve entered the cash bonus into your payroll system it will automatically be included on the employee’s year-end Form W-2.
Tips & Warnings
- Have each employee who receives a cash bonus sign a document acknowledging receipt of the cash.
- If the employee has reached the maximum withholding limit for Social Security tax for the year, do not include the 6.2 percent Social Security tax in your calculations.
- If an employee has received more than $1 million in compensation for the year, use 35 percent for the FIT rate.
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