My firm has worked with many taxpayers and companies over the years, and I have seen employees receive their bonuses in a variety of ways. So has the IRS. As a result, the IRS has standardized how employers must handle the process of paying bonuses to their employees. Bonuses must be reported as employee earnings and added to the employee’s W-2—not issued as a separate type of income reported on a 1099-MISC.
If the income is reported on a 1099-MISC, the employee could be responsible for both the employer and the employee’s share of FICA taxes, vs. just the employee portion.
Despite it being clear how bonuses should be taxed, employees still have questions about this subject. Here are a couple of the most common questions I receive from clients about their bonuses.
“I get my bonus in January. My employer adds my bonus directly to my regular paycheck. Is it taxed differently than it would be if I received a separate check?”
There are two different concepts here: your tax rate and the amount of your withholding. Your tax rate will be based on your overall income, not whether your bonus is separate or added to your paycheck. As your earnings grow, so does your tax bracket. A bonus of $5,000 might not change your tax rate, but a bonus of $25,000 could put some, or all, of that bonus into a higher bracket.
While your entire income won’t be taxed at the higher tax rate, some or all of your bonus could be. If your bonus bumps you into a higher tax bracket, only taxable income within that level is taxed at that rate.
As far as the amount of withholding is concerned, that depends on whether the bonus is added to your paycheck or paid separately. When the bonus is added to a regular paycheck, the payroll department will use the withholding rate from the Form W-4 you filled out early in the year. When your bonus comes in a separate check, however, payroll doesn’t use your regular withholding amount. Instead, because these are supplemental wages, the payroll department must withhold a flat rate of 25 percent. When the supplemental wages exceed $1 million, the flat rate soars to 39.6 percent.
“I get my bonus in January, but it’s already included in last year’s W-2. What can I do if I don’t want to pay tax on money I didn’t receive until the following year?”
If your bonus is included in last year’s W-2 before you receive that money, the doctrine of constructive receipt, which says that income is constructively received when an amount is credited to your account or made available to you without restriction, works in your favor. The amount must be included in your gross income the year you constructively receive it, not before.
In order to rectify the situation, prepare Form 4852, which is a substitute for a W-2 or 1099-R. Enter the correct amount of wages and withholding using your W-2, and subtract the income and withholding from the paycheck you received in January.
Include with Form 4852 a statement that you received the bonus check in January. If your check was mailed to you, save the envelope to prove when it was postmarked. If your check was deposited electronically, print out a statement as proof.
File the return on paper, not electronically, and remember to include the bonus check income and withholding in next year’s tax return. If you think you won’t remember, you may want to simply report the income despite receiving the bonus check in January. If your company does this annually, it will balance out in the long run.
Eva Rosenberg, EA is the publisher of TaxMama.com ®, where your tax questions are answered. She is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.