As the spirit of generosity is in the air, companies and employees need to know that holiday bonuses are considered supplemental wages and subject to taxes. Holiday bonuses are viewed by the IRS as compensation, just like paychecks, so taxes need to be withheld from your holiday bonus.
How Much are Holiday Bonuses Taxed?
Some of the taxes you will need to pay on your holiday bonus include:
Social security tax:
You pay social security tax on all compensation up to $132,900 in 2019. If you haven’t passed this threshold, then you can expect your employer to deduct 6.20% from your bonus for social security.
Medicare tax:
You can expect another 1.45% to be deducted from your holiday bonus for Medicare tax.
Federal income tax:
The IRS requires a set percentage of your bonus to be withheld when you receive it. This is because your holiday bonus is considered a supplemental income. Under tax reform, the federal tax rate for withholding on a bonus was lowered to 22%. This is lower than the federal income tax rate of 25%.
State income tax:
depending on which state you live in, state income tax will be withheld at the rate the state requires by law.
Retirement Plans (401k):
If you have requested that your employer contribute a portion of your wages to your retirement plan, then the rate at which you have set will be the same rate that will be taken out of your holiday bonus.
Ultimately, you should check with your employer about your holiday bonus and taxes. Your employer has the option to combine your regular paycheck and holiday bonus and withhold taxes on the whole amount. If your employer does this, it may result in a higher withholding than 22%.
If this is the case, don’t worry as you will eventually get some of the money back as part of your federal tax refund when you file your taxes.
How to Avoid Holiday Bonus Tax
Are there any ways to avoid paying tax on the bonus? No. And failing to report and pay taxes could lead to problems down the road. But there are ways to minimize or delay the impact. Here are three options:
Give a little more:
Employers can estimate the taxes an employee would have to pay on the bonus and add that to the total amount. That way, after taxes, the employee would get to keep the intended bonus amount. Obviously, this requires the employer to be more generous, which is not always possible.
Invest in the future:
Another option – that would avoid both payroll and income taxes – is to put the bonus into the employee’s 401K retirement plan. While employees would not actually receive a check during the holidays, they would also not have to pay taxes on that money until they withdraw it. In the meantime, that bonus could continue to grow.
Kick Off a Healthy New Year:
Employers can decide to award holiday bonuses in January and offer the option of placing the money in a Flexible Spending Account for healthcare. None of that money would be taxed, but the employee would have to use it on qualifying health or dependent care expenses.
If you’re an employee and your company will not offer any of the options above, then do your best to plan ahead and factor the taxes into your holiday budget. And if it makes you feel any better, giving is always better than receiving.
Looking for assistance with tax relief? Optima Tax Relief’s licensed professionals offer a range of tax services to help you. Reach out for a consultation today.