I am a single man living and working in New York City. For my normal paychecks, the total tax withheld is roughly 34%, including city, state, and Federal withholdings. I recently got a small bonus as part of my company's employee referral program and was taxed at a near 50% rate. Why do they insist on bilking me of a larger proportion of my bonus?
No one is bilking you. This is perfectly legit. Just know that if you're expecting a midyear bonus, year-end bonus or any other kind of supplementary income, at least 28% of it will be withheld for federal tax purposes. That's just the way it is.
Your question just gets to the heart of our "graduated" tax system. To figure out your tax bill, you can't just apply a flat rate to your gross wages. For instance, if your taxable income is $70,000 as a single guy, you fall in the 31% federal tax bracket. But you can't just multiply that amount by 31% and assume that's your tax bill. Because the rates are graduated, only a portion of your salary is taxed at 31%; the rest is taxed at lower levels. In the end, your tax bill actually will be lower than if you'd applied a flat rate.
But in most instances, your bonus is considered a "supplemental wage" and is not subject to the same rules. It gets hit with a flat federal rate of 28%. No tricky calculations there.
That's the minimum your employer must withhold on a bonus, says Clarence Kehoe, partner and director of employee benefits at
Anchin Block & Anchin
, a New York accounting firm. You may be able to request to have more withheld, but definitely not less.
I'll assume you're in the 28% federal income tax bracket. Then take out state tax, city tax, Social Security, Medicare, and hopefully a 401(k) contribution, and Uncle Sam ends up keeping close to 34%.
But, remember, because you're in the 28% bracket, you just can't slap 28% on your wages and assume you've calculated you federal tax bill.
Let's assume your annual taxable income is $40,000. As a single guy, the first $26,250 is subject to the 15% federal income tax rate, according to the tax code. That's $3,938. The $13,750 remainder "graduates" to the 28% rate, or $3,850. Your total tax then is $7,788 (3,850 + 3,938). Using ballpark figures, if you get paid twice a month, around $324 should be withheld from your check each week for federal tax.
But if you just took a flat 28% of $40,000, you'd get $11,200 in taxes, much more than the graduated amount.
That's why your bonus check has more money withheld for taxes. It just gets hit with the flat 28%. "Pull out state, city, Social Security, Medicare and 401(k) and that's why it seems like 50% of your bonus disappears," says Jim Seidel, managing editor at
, an information provider to tax professionals. Note: 401(k) contributions typically are taken out of bonuses.
Blame It on Your Boss
Your employer actually can choose how to withhold on your bonus. Obviously, slapping a 28% rate on it is the simplest, so most opt for the easy way out.
But your employer also can elect to add your bonus to that period's wages and then figure out how much to withhold on that larger amount, says Kehoe; accountants call this the annualized method.
If you make $2,500 a month but get a $5,000 midyear bonus, your withholding will be computed as if you received a single wage payment of $7,500 for the monthly payroll period. Then that $7,500 is annualized, or assumed to be part of your yearly salary. So if you earned $7,500 a month, you'd be making $90,000 annually versus $30,000. But at $90,000, your tax rate jumps to the 31% tax bracket vs. the 28%.
Under this annualized method, you would end up taking home even less of your bonus because you'd be withheld at much higher rates.
If It Walks Like a Duck
It doesn't matter whether your salary is $90,000 and you get a $200,000 bonus or your salary is $290,000, says Kent Noard, a partner at
Sterling Wood Financial
, in San Jose, Calif. Either way, you owe Uncle Sam tax on $290,000 at the end of the year.
So if you've received a bonus, be sure to analyze your current tax situation. Drop your annual wage and bonus numbers into
or some other tax preparation software and determine your withholding situation.
Remember, your federal withholding and/or your estimated tax payments must equal either 100% of last year's federal income tax or 90% of your projected 2000 federal tax bill, whichever is less. (If your 1999 adjusted gross income exceeds $150,000, the total must equal 108.6% of last year's bill.) So you want to make sure you meet either of these requirements or you'll be hit with an underpayment penalty in April.
If you're typically in the 15% federal tax bracket, and you had 28% withheld on your bonus, you may have had enough tax withheld already. You will get any extra back as a refund when you file your tax return in April. So why not adjust your
-- Employee's Withholding Allowance Certificate
? That's the form that tells your employer how much to withhold from your wages each pay period. You can have less withheld for the rest of the year if you've already paid in enough. (Check out this previous
Tax Forum for more on adjusting your W-4.)
On the flipside, if you're in the 39.6% tax bracket and you've only had 28% withheld on your bonus, you're going to owe that 12% difference in April, says Martin Nissenbaum, national director of personal income tax planning at
Ernst & Young
. So you may need to increase your withholdings or start making estimated tax payments. Check out this previous
story for more details on estimated payments.
Note that if you change your W-4, your employer is not required to implement those changes for 30 days, says Nissenbaum.
If you left the company and you're still owed a bonus, you will be withheld under the annualized method, says Nissenbaum. The 28% only applies if you had regular withholding from the company within the same year, he says.
Granted, this seems like a bummer now, but at least you won't have to cough up a big chunk of money in April.
I know. That's zero consolation.
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Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for wsj.com and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for TheStreet.com. Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University. Byrnes appreciates your feedback;
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