Federal Income Tax on a Year-End Bonus in California

At the end of the year, some employers reward their employees with year-end bonuses. This can be a nice way to close out the year, but it can also bring questions about taxes. How will the IRS treat your year-end bonus when taxes come due in a few months? If your employer withholds taxes from your paychecks, they have already done most of the work for you. Depending on the size of the bonus, our Los Angeles tax advisors feel that it is often still a good idea to make sure you will not get any surprises in your tax return.

Which Bonuses Are Taxable?

Year-end bonuses can be extremely generous, or they can be a token of an employer’s appreciation (emphasis on “token.”) A bonus could take the form of a fruit basket or other gift item, or it could come in check form.

Small gift items are not necessarily considered “income” for federal tax purposes. You probably do not have to report that fruit basket, for example. Larger gifts, like a car or something similarly pricey, will count as “income.” If your employer hands you a check at the end of the year, that is definitely taxable income.

Tax Withholding Applies to Your Bonus, Too

As mentioned earlier, if your employer is already withholding taxes from your paychecks, they should do the same for your year-end bonus. They will also report the withheld taxes for you on your W-2.

Taxes for Social Security and Medicare are withheld the same way they are on your regular paycheck. Federal income tax law has different rules for bonuses and other payments that supplement your wages. It also applies a different tax rate for bonuses in excess of $1 million, should you be so lucky.

The IRS generally considers year-end bonuses to be “supplemental income,” which may be subject to different withholding than regular income. If your year-end bonus is included in a paycheck, your employer will most likely calculate withholding using the same method it uses for your other paychecks. If your bonus is separate from your regular paycheck, however, your employer may use one of two different withholding methods:

Aggregate Withholding

The “aggregate method” refers to the withholding amount for the pay period when you received the bonus. It is often more complicated than the second method, and it can actually result in a higher amount of withholding.

Percentage Withholding

The second option is for your employer to withhold a flat percentage of your bonus for federal income tax. As of the end of 2019, the flat percentage rate is twenty-two percent.

Bonuses Over $1 Million

If you receive a bonus of more than $1 million, everything up to $1 million is subject to withholding at the same rate of twenty-two percent discussed above. For everything over $1 million, the withholding rate is thirty-seven percent.

A year-end bonus of $1.75 million would therefore result in a check for $1,252,500. Your employer would withhold 22% of the first $1 million ($220,000), and 37% of the remaining $750,000 ($277,500), for a total withholding amount of $497,500. At least your bonus was more than a fruit basket, though.

If you need assistance with an issue related to payroll taxes in California, the Enterprise Consultants Group’s tax advisors are available to answer your questions and discuss your rights and options. Please contact us today online or at (800) 575-9284 to see how we can help you.

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