Bonuses can be an instrumental part of your overall compensation package. Whether you are getting a sign-on bonus, commission check, or annual performance bonuses, this supplemental income is a welcome part of any compensation package.
However, sticker shock might occur when you receive your bonus paycheck. Like regular paychecks, businesses must withhold taxes from your gross bonus payment. Here's how bonuses are taxed.
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What Are Bonuses?
Bonuses are payments made to employees beyond their regular salary. They usually come as lump-sum cash payments processed through your regular payroll provider. Bonus payments can be a significant windfall and boost your discretionary income.
Depending on when you receive your bonus, it can be incorporated into your regular paycheck or come during an off-cycle payment.
- Annual Bonuses are individual and company performance-based bonus payments. They are included in your offer letter. They are structured as a percentage of your yearly salary. For example, an associate might have a 15% bonus tied to a $100,000 base salary.
Your bonus percentage tends to increase with title, tenure, and responsibility advancements. The higher you get in your company, the larger your bonus will be as a percentage of your annual cash compensation. Getting a promotion can increase your yearly bonus percentage.
- Quarterly Bonuses can also be given to employees as part of a performance-based incentive plan. Some revenue-generating companies may reward employees based on meeting quarterly milestones. Alternatively, sales teams can receive quarterly bonuses for beating internal goals or key performance indicators.
- Spot Bonuses are issued to employees who meet short-term goals. These goals could include winning internal sales competitions, receiving a new certification, or exceeding expectations in their role.
Spot bonuses tend to be smaller than annual or quarterly bonuses. They range from a few hundred to thousands of dollars. They can be highly motivating and foster internal competition and advancement.
- Commission Checks are generally issued to employees in sales roles. They are based on a pre-set commission agreement. For example, sales teams may earn a 2-5% commission rate. This means that if you sell $100,000, you earn a $2,000 to $5,000 commission.
Commission checks are usually paid out retroactively, which means you will receive them after your sale closes. For processing efficiency, companies typically batch commission check payments on a certain day of the month or quarter.
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How Are Bonuses Taxed?
Getting a bonus is always an exciting day for employees. However, you need to understand how bonuses are taxed. Bonus tax rates and methodology tremendously impact your net bonus check (what shows up in your bank account).
Your company must withhold taxes from your bonus when they pay you, a process known as tax withholdings. Your withholding rate is calculated based on how you complete your Form W-4.
Companies can tax your bonus payment in two main ways: percentage or aggregate method. Here's how each methodology works:
Percentage Method
The percentage method is a popular way for companies or payroll processing companies to calculate bonus tax withholdings. Your human resources department designates your bonus payment as supplemental income, and your payroll system processes it according to predetermined rules.
The IRS sets the percentage, or flat rate, for supplemental wages at 22%. Any bonus or supplemental wages up to $1,000,000 at taxed at 22%, while bonuses totaling over $1,000,000 for the year are taxed at 37%
Example: Sarah earns a $25,000 year-end bonus. Her tax withholdings are calculated as $25,000 X 22% = $5,500. Sarah's remaining net bonus payment will be approximately $19,500.
If Sarah had instead earned a $1,025,000 bonus, the first $1,000,000 would be taxed at 22%, and the $25,000 above that would be taxed at 37%.
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Aggregate Method
The aggregate method doesn’t use a flat rate to calculate your tax withholding. Instead, your bonus and regular paycheck use the same tax rate as your ordinary paycheck. This tax withholding rate uses your ordinary income tax bracket.
If your company pays bonuses with regular payroll using the aggregate method, your tax rate will often be higher than the 22% used by the aggregate method.
Example: John earns a $30,000 year-end bonus, which is paid in addition to his regular monthly income of $10,000. As a single filer with a salary of $120,000, John is in the 24% tax bracket. But with the addition of his $30,000 bonus, John's yearly income is now calculated as $40,000 X 12 months, or $480,000, in the month he receives his bonus. His bonus is now taxed at the 35% tax bracket.
Read More: How to Choose Your Tax Filing Status
2025 Tax Rates:
| Tax Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
|---|---|---|---|---|
| 10% | $0 – $11,925 | $0 – $23,850 | $0 – $11,600 |
$0 – $17,000 |
| 12% | $11,926 – $48,475 | $23,851 – $96,950 | $0 – $11,925 | $17,001 – $64,850 |
| 22% | $48,476 – $103,350 | $96,951 – $206,700 | $11,926 – $48,475 | $64,851 – $103,350 |
| 24% | $103,351 – $197,300 | $206,701 – $394,600 | $48,476 – $103,350 | $103,351 – $197,300 |
| 32% | $197,301 – $250,525 | $394,601 – $501,050 | $103,351 – $197,300 | 197,301 – $250,500 |
| 35% | $250,526 – $626,350 | $501,051 – $751,600 | $197,301 – $250,525 | $250,501 – $626,350 |
| 37% | Over $626,351 | Over $751,601 | Over $375,801 | Over $626,351 |
What If My Tax Withholding Are Too High?
You could be entitled to a tax refund if your tax withholding rate is too high for the year. In this scenario, you paid too much in taxes throughout the year. You can save an emergency fund, invest in stocks, or pay off debt with your tax refund.
The converse is also true. You might have a tax liability if your tax withholding rate is too low. When you are filing your annual taxes, you might be required to write a check for taxes owed to the IRS. You can calibrate your tax withholding rate via your Form W-4.
What Counts as Supplemental Wages?
Bonuses are considered “supplemental wages,” according to the Internal Revenue Service. Supplemental wages are defined as wages earned outside of your regular wages or salary. [1]
The IRS counts sign-on, annual, quarterly spot, or otherwise bonuses as supplemental wages. Here is a list of other compensation that the IRS considers supplemental wages:
- Bonuses
- Commissions (exceptions apply)
- Overtime
- Retroactive Pay Increases
- Severance Pay
- Back Pay
- Non-deductible Moving Expenses
- Prizes
- Awards
Smart Summary
Bonuses are defined as supplemental income by the IRS. Companies must withhold taxes from employees’ paychecks using the percentage or aggregate method. The combination of how your company calculates your bonus taxes and Form W-4 elections determines if you will owe a tax liability or get a tax refund when you file your taxes. (Read more about the Best Online Tax Filing Software).
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(1) Internal Revenue Service. Publication 15 (Circular E), Employer’s Tax Guide. Last Accessed March 5, 2025.
