Congratulations on your bonus! As 2019 comes to a close, many employees will be receiving a supplemental wage or cash bonus at year-end. Before you start thinking about what you are going to spend it on i.e. holiday gifts, there are some tax planning considerations to think about.
How are bonuses taxed?:
First of all, let’s look at how the IRS taxes a cash bonus. Your employer is required to withhold taxes on a bonus similar to the same withholding rules that are required on regular wages.
Withholding rate when an employee receives more than $1,000,000:
If a bonus exceeds $1,000,000, the excess of $1,000,000 is subject to withholding at 37%. This is without regard to the employee’s Form W-4.
Withholding rate when an employee receives less than $1,000,000.
If your employer pays your bonus with regular wages but doesn’t specify the amount of each payment, your employer must withhold federal income tax as if the total was a single payment for a regular payroll period.
If your employer pays supplemental wages separately (or combine them in a single payment and specifies the amount of each), the federal income tax withholding is usually calculated at a flat rate of 22% for the bonus.
Tax planning opportunities:
Defer your bonus to the following year:
Sometimes deferring the payment of your bonus enables you to push the income into a year that you will expect to incur a large number of tax deductions. You can also defer your bonus by maximizing your retirement contributions.
Place the bonus in a deferred compensation plan:
A deferred compensation plan withholds a portion of an employee’s pay until a specified date, usually retirement. The lump-sum owed to an employee in this type of plan is paid out on that date. Examples of deferred compensation plans include pensions, retirement plans, and
employee stock options.
Contribute to a health savings account:
If your employer offers a health savings account, you can contribute a maximum of $7,000 for a family plan or $3,500 for an individual plan in 2019. These contributions are tax-deductible.
Create a donor-advised fund:
If you are inclined to give, accelerating charitable contributions using a donor-advised fund allows you to take the tax deduction to offset the increase in taxable income. Charitable deductions are now available up to 60% of your income.
Gifting cash to loved ones and friends:
Many grandparents or others like to give to family and friends around the holiday season. You can gift up to $15,000, for 2019, to each individual without having to file a gift tax return, use your lifetime estate and gift tax exemption, or pay a gift tax.
Every taxpayer’s situation is different, and if you would like to explore the income tax effect of your options, we would be happy to assist you.