How to Reduce Taxes on Bonus Checks Your boss tells you that you’ve earned a bonus. Congrats! But don’t spend all that money yet—because chances are, you’ll be shocked when you actually receive the check. Often, a huge amount of your bonus is withheld for taxes. Here’s why—and how you can avoid this problem.
Most employers use automatic payroll systems to help them handle this recurring chore. The boss tells the computer how much money you receive in each paycheck and how often paychecks are issued. The computer knows what the tax withholding requirements are—for federal, state, and Social Security taxes, and it also knows what to withhold for 401(k) contributions, insurance, and other deductions.
For example, if you earn $48,000 a year and are paid twice a month, each paycheck is $2,000. The computer knows the proper tax bracket for someone earning $48,000 —so it deducts the proper amount from each paycheck so that the taxes are correctly withheld for the year.
But, say you’re paid every two weeks and you now suddenly receive a one-time bonus of $10,000. Many payroll systems (for some stupid reason) think you’re going to receive this amount every two weeks—not just once! And someone who gets a $10,000 check twice a month is in a higher tax bracket than someone who gets $2,000 each paycheck. As a result, the computer withholds a huge amount of money from your taxes—enough to pay taxes at the much higher rate, even though you’re not really earning enough to be taxed at that higher rate. Consequently, as much as a third of your bonus can be withheld from you! Imagine your reaction when you get a $6,667 check for a $10,000 bonus!
Oh, sure, you’ll eventually get the extra tax withholding back—but only after you file your tax return next April. That means the IRS gets free use of your money for as much as a year or longer! This is a very annoying situation, and one you should avoid. Here’s how.
Right before you receive your bonus, submit a new W-4 form with your boss, changing the number of exemptions on your payroll. By increasing your exemptions, the government will withhold less taxes. Then, after you get the bonus, submit another W-4 to restore your exemptions to the normal level. This fools the computers into giving you the money that is rightfully yours
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posted: Jan. 30, 2006 @ 8:08a
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posted: Jan. 30, 2006 @ 8:52a
The explanation you provided on why the tax rate on bonuses seems higher is correct. The W4 method you described would work, but it is extra work that doesn't need to be done by you, or your payroll person. Just ask your payroll person to cut your bonus as a separate check, and to withhold the taxes at a bonus tax frequency, and you should be all set. Most of the major payroll software companies have this as an option. I just wanted to give you an easier way to take care of this, in case you wanted to use it.
posted: Jan. 30, 2006 @ 8:56a
Unfortunately if you work for OmnicCorp International or something similar, chances are you are getting a year-end bonus along with 10,000 other people, and you cannot request a personal favor from the payroll dept. I work for such a company and sadly, even their software does the large withholding mentioned above.
Senior Member - 1K
posted: Jan. 30, 2006 @ 8:58a
Previous discussion of this topic is also covered in this thread. For further related information on withholding, see IRS Publication 505 .
Back in Rehab
posted: Jan. 30, 2006 @ 9:08a
link Not sure if anybody has put this link up before but it's a great tool for figuring regular and bonus paychecks
Stand up guy
posted: Jan. 30, 2006 @ 9:22a
Evilmagus said: [Q]Unfortunately if you work for OmnicCorp International or something similar, chances are you are getting a year-end bonus along with 10,000 other people, and you cannot request a personal favor from the payroll dept. I work for such a company and sadly, even their software does the large withholding mentioned above.
No sympathy from me. It's been years since I worked for a company that even PAID bonuses, except for the senior execs.
posted: Jan. 30, 2006 @ 9:22a
If bonus income is a normal and significant part of your compensation, just "under-withhold" for the rest of the year by claiming a higher number of exemptions on your W-4. This "leveling" technique can be used to adjust for other external income sources as well, withholding more or less from your regular income to compensate for other income that you may realize during the year. And yes, this is entirely appropriate under IRS guidelines.
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