Don't Mess With Taxes

Although hybrid work is still around, most companies returned mostly to pre-COVID-19 pandemic operations in 2023. That apparently includes bonuses for workers.

These added employee payments came back in a big way this year, according to a survey last month by the national staffing firm Robert Half. The agency found that 96 percent of employers expect to award year-end bonuses, with 54 percent of those generous employers saying the amounts will be more than a year ago.

If you're among those who got a little (or a lot of) extra cash from your boss, congratulations.

Now let's talk taxes.

Bonus is taxable income: Yep, that money is not a gift from your employer. It's additional taxable income.

So, depending on how your company doles out the bonus, your $1,000 end-of-year reward might not actually be a full one grand in your hands. If it's part of one of your last paychecks of the year, the Internal Revenue Service will get its cut as it does through regular payroll withholding.

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.

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: As noted earlier, 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 $160,200 in 2023) 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 the withheld amount turns out to be too much based on your overall tax circumstances, you'll get the excess back when you file your return. Though it's not quite the same thing, it is a bit of a filing season bonus

And 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.

Employer gross-up option: Some companies choose to give their workers a specific dollar amount, such as a flat $500.

That's accomplished when the company opts to gross up the check. This is adding the taxes owed on the bonus to the amount the firm wants to award its workers.

Grossing up a bonus will mean higher taxable wages will be reported on the employees' W-2 forms issued next year. But it also means that the worker gets the full intended cash, and the employer gets more goodwill from workers.

Small, not taxable company gifts: At the other end of the year-end employee reward scale are the small gifts, discussed briefly earlier, that many firms give staff in lieu of or in addition to a bonus.

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, we all know the IRS cares about all sorts of compensation, large, small, or middling. 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 moves, such as adding to a traditional IRA that will provide you a tax deduction at filing time and possibly reduce your 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:

• Tax-free office holiday parties and employee gifts
• Buyouts and early retirement packages are taxable income
• Houston-based energy company gives every employee a $100,000 bonus and yes, the workplace reward is taxable

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