Question:
I work in sales and receive a base salary plus quarterly bonuses. It seems that my bonuses take a higher tax hit versus my wages. I've asked for clarification and have received conflicting answers: 1) Bonuses are taxed more up front, but then they are lumped together on the W-2 form at the end of the year and all of my earnings are taxed the same, or 2) Bonuses are considered specialy payments and thus more taxes are withheld. Does anyone know which is correct?
My company is offering to let us go to straight commission. I'd still be an employee (not a contractor) and would receive a w-2 form. Although the earning potential is somewhat higher I'd like to know if the tax rate will also be higher.
Thanks!
Answers:
They do hold out more up front because that bonus may bump you to the next tax bracket and they don't want you to get hit with a higher tax on your regular pay that what they were deducting on it during the year.
However, when all is said and done, you will pay what you owe on taxes. You won't pay a higher rate just because you got a bonus. For instance, you make $45K in wages and have a $10K bonus, your income is $55K and you will pay the same tax at the end of the year as someone who made $55K in all wages.
Taxed at a higher rate to avoid getting a big tax due hit when your salary takes a big bump on the tax schedule
some companies do. My husbands profit share checks, which are like a bonus, get what is called luxury tax put on them. it sucks its like 45% or higher i think.
Typical withholding rate on bonuses is 25%, but doesn't necessarily match what your taxes due will actually be come tax return time. The actual tax rate varies based on your annual gross. With commission checks being different every time, it's hard to tell what your actual tax rate will be, especially early in the year. Live with the 25% withholding and put an extra 5% aside, just in case. If you get more withheld that you need, you get a refund later-better than being under withheld and having to come up with the extra money unexpectedly. Commissions are different than bonuses and should be taxed at whatever tax bracket you fall in for that paycheck.
The rules are in IRS publication 15, which can be found at the www.irs.com webstite and either downloaded in PDF format or viewed online.
Very basically, bonus payments are a type of "supplemental wages". One of the "supplemental wage withholding methods" must be used. The two most common methods are discussed in IRS publication 15, and it is normally the employer's choice as to which legal method is used.
Both are correct, actually. Item #2 is a partial restatement of #1.
Bonuses and other irregular payments are withheld at a statutory rate of 25%. That is just lumped in with the rest of the wages and withholdings reported on your W-2.
At filing time bonuses are just part of your wages are are not taxed at a different rate.
It may depend on the state in which you live (for both income tax, if your state assesses one, and for state taxes on bonus) and your federal income tax bracket (more income -> higher tax bracket -> Uncle Sam digs deeper into your wallet). You can find the US tax bracket breakdown on Wikipedia.
BTW, I had a signing bonus recently that was taxed @ 25%, which I'm told is standard. I don't know for sure if this applies to other kinds of bonuses (quarterly, year-end, etc.).
It also depends on how many exemptions you claim on your W-2 form. Claim at least '1' (for yourself), and additional for each dependent and/or spouse.
Best bet for you seems to be to talk to your employer's benefits provider and get solid financial advice from them. Talking to a financial adviser is usually provided free through your employer. You can usually ask them questions about your situation, in addition to 401(k), IRA, ESPP, ESO, etc.
All W-2 income is taxed at the same rate (commissions, bonuses, regular pay). Payroll withholdings are different based on the timing of payments, but in the end, you will pay the same tax rate on all your W-2 earnings.
When you get a big payment (a bonus, for instance), the withholding calculator makes the assumption that this might be a regular thing and bumps your withholdings up to a higher rate. But when you file your return, that is when your actual rate is determined, and most likely a refund will be in store for you.
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