Why Bonuses Have More Taxes Withheld Than Regular Paychecks

Introduction

Payment of bonuses is a common practice in many workplaces. However, many employees have noticed that the taxes withheld from bonuses are significantly higher than those deducted from their regular paychecks. This article explains why this happens and the reasons behind the higher withholding rates for bonuses.

The Reason Behind Higher Withholding Rates for Bonuses

The higher tax withholding rates on bonuses are not because the bonus itself is taxed more. The actual tax rates are calculated on the 1040 form when you file taxes. Instead, bonuses are taxed at a higher rate due to the way payroll systems handle bonuses.

How Payroll Systems Calculate Bonuses

Most payroll systems were not designed to handle bonuses efficiently. As a result, the tax withholding for bonuses is generally calculated based on a simplified formula to ensure a smoother processing workflow. The IRS has set a minimum rate of 22% to avoid complications with bonus payments.

Example: How it Works

Let's consider an example. Your biweekly paycheck is $4,000, with $17 withheld for taxes. In reality, your tax rate is not 600 per check, but rather a blended tax rate. Here's the breakdown:

The first $11,000 of your annual $104,000 salary is tax-exempt. The next $33,725 is taxed at 10%. The next $50,625 is taxed at 22%. Any amount above $95,375 is taxed at 24%.

Your actual blended tax rate is around 8%. However, if you receive a bonus of the same amount as your regular paycheck, the withholding amount would be based on 24% (the marginal rate), which is why the withholding is higher.

The Impact on Tax Refunds or Owe

While the higher withholding rate for bonuses may seem unfair, it generally does not have a significant impact on the actual tax refund or the amount owed at the end of the year. Here's how different income brackets are affected:

Over-Withholding and Under-Withholding

Those Making Less Than $45,000: Are over-withheld by $1,000 and will receive this refund at year-end. Those Making Between $45,000 and $95,000: Are under-withheld by $2 and will need to pay this when they file their year-end tax form. Those Making More Than $231,000: Are under-withheld by $10 of the bonus and will have to pay this when they file their year-end tax form.

In most cases, those at the 22% marginal tax rate are not significantly affected, as the higher withholding rate does not change their overall tax situation.

Conclusion

The higher withholding rate for bonuses is a standard practice designed to simplify the tax calculation process for payroll systems. While it may seem counterintuitive at first, it actually has little impact on the total tax bill for most taxpayers. Understanding how this system works can help employees better manage their finances and expectations regarding tax refunds and payments.

Further Reading

Tax Topic 450: Income Tax Withholding Circular E: Employer's Tax Guide Tax Topic 501: Salary, Wages, Tips, and Other Compensation