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Ho! Ho! Holiday bonus (and tax) time

Holiday bonus cash in a Santa bag-cropped

December 1998 was hectic. The hubby was in California, getting onboarded for his new job, which actually would be in Florida. Our cat and I were in suburban Maryland, finishing up packing for our move to the Sunshine State.

Most of that packing was done from 7 p.m. into the early morning hours, as I was still commuting to my job in downtown Washington, D.C., during the day. I had planned to quit so I could focus on the move, which was scheduled for early in the new year.

However, a heads-up from a buddy in my company's Human Resources office changed that. He told me I needed to be on the payroll on Dec. 31 to collect my annual bonus.

So I stayed on staff until Jan. 2, 1999, and pocketed a nice check that helped with our relocation. It also paid for a gift card I sent him as thanks.

Types of bonuses and their requirements: That employment-bonus connection is not unusual. A recent post at Holland & Hart's The Benefits Dial blog notes —

"Many bonus and incentive programs require that the intended recipient remain employed with the employer through the date of payment. If the employee quits before the payment date, the employee is not entitled to receive the bonus. In fact, many bonuses are granted specifically in order to retain the employee."

But, writes attorney Brenda R. Berg, a partner at the law firm's Denver office, "A new interpretation by the Colorado Department of Labor and Employment (CDLE) could have significant tax impacts under Internal Revenue Code Section 409A (409A)." That's the tax code section dealing with nonqualified deferred compensation.

If the CDLE interpretation is applied to retention bonuses, notes Berg, the bonuses might not, in fact, be forfeitable if the employee quits before the payment date. And that could have even greater impacts — and difficulties for compliance — on other types of awards that are common, such as restricted stock unit or incentive award arrangements that extend over many years, according to Berg.

Don't leave. I'm not going to get into labor law and taxes. For that, check out Berg's post, along with the item from her H&H colleague Juan Obregon.

But I do want to touch on the tax implications for recipients of holiday or year-end or whatever-it's-called added cash.

Bonus is taxable income: First things first. It's no surprise to taxpayers that the Internal Revenue Service considers bonus money as taxable income.

So, as I noted in my earlier Bonuses comes with tax baggage post, your $1,000 bonus is not going to translate into a full one grand in your hands.

But, hey, any amount of additional money is, well, a bonus. I don't know of anyone who's turned down a bonus because of the tax implications. But do be aware of those tax matters and their effect on your bonus.

And if you're getting one, consider yourself lucky, even with taxes taken into account, since fewer companies apparently are handing out bonuses this year compared with last year.

Defining a bonus: The IRS says a bonus is any payment made from an employer to an employee that is in addition to regular compensation. The amounts generally are included in your income and shown on the Form W-2 that details your earnings.

It can be cash or non-cash. A holiday bonus is taxable, even if it is presented as a gift. Note however, that if you receive a small non-cash holiday gift from your employer, such as a ham or popcorn tin, you don't have to claim the value of this small gift as a bonus. More on these mini gifts a little later in this post.

Methods of bonus taxation: When your bonus is added to your regular pay, it's taxed just like your earnings. Your employer calculates taxes using the withholding amount you provided on the Form W-4 you provided your boss and which has been used to figure those amounts for each pay period. This means the regular Social Security (up to earnings of $147,000 in 2022) and Medicare payroll taxes are taken out of the added income.

If, however, you get your bonus separate from your regular pay, your employer must use an IRS-approved method to determine how much tax should be withheld. That could be by withholding a flat 22 percent (this rate was dropped from the 25 percent level by the 2017 tax reform law) income tax from your bonus amount. If that turns out to be too much based on your overall tax circumstances, you'll get the excess back when you file your return.

Don't forget your state income taxes, which are assessed by most jurisdictions. Those will be withheld on your bonus money, too, at the rate required by state law.

Small, not taxable company gifts: There's good tax news, though, for those small gifts you got in lieu of or in addition to your bonus discussed (briefly) earlier. The IRS specifically excludes these gifts under its de minimis fringe benefits rule.

That's Latin for "of minimal value" and IRS-speak for in these small-value cases "we don't care."

OK, what the IRS really says is the fair market value of the gift is "so small as to make accounting for it unreasonable or impractical."

And that amount is…? The IRS uses the always fun facts and circumstances standard for deciding what is or isn't de minimis, but a memo the agency issued in 2001 ruled that in that particular case that items with a value exceeding $100 could not be considered de minimis.

Potential tax bracket bump: If your bonus is substantial (good for you!), or you're already nudging a tax bracket line, a bonus potentially could push you into a higher tax bracket (not so good for you). That means you'll pay a higher tax rate on the added money.

But not all of your bonus is lost. Our progressive tax system means you still should come out OK, since only the amount that falls into the new higher bracket is taxed at your new top rate.

However, you do need to be aware of this possibility, in case you want to make some December tax moves (such as adding to a tax-deferred retirement plan) that could reduce this year's bonus-boosted tax bill.

I hope all this tax talk about bonuses doesn't ruin your holiday cash from your boss. Who am I kidding? Of course, it doesn't because you're still getting extra money, even after taxes. Enjoy!

You also might find these items of interest:



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