This article was written by Cassandra Wanlass, Payroll Processing Manger at Helpside.
This time of the year, many employers choose to pay bonus payments to employees. Bonuses are a type of compensation paid to employees in addition to their salary, commissions, or wages. The amount is considered income and is subject to income tax withholding, Social Security, Medicare, and FUTA.
Types of Bonus Payments
Discretionary bonuses are paid to employees at the discretion of the employer. These bonuses are not specifically tied to business profits or work performance but are typically a gesture of gratitude for employees’ efforts. For example, spot, holiday, retention, and annual bonuses are all considered discretionary because these bonuses are not promised or guaranteed.
Nondiscretionary bonuses are based on completing predetermined conditions. For example, the employer may want to incentivize the employee if they meet certain job requirements or company goals. Hiring and attendance bonuses, bonuses for quality of work, and individual or group production bonuses are all promised or guaranteed.
**Please note that nondiscretionary bonuses are considered wages in the calculation of overtime for all non-exempt employees. **
Taxation of Bonus Payments
Bonuses can be processed using the following taxation options:
- The Aggregate Method: The bonus is processed with the employees’ regular wages. This method will tax the bonus at the employees’ current W-4 tax rate.
- The Percentage Method: The bonus is processed as a separate check. This method will tax the bonus at the IRS supplemental flat rate of 22%, (for bonuses of less than or equal to $1 million in a calendar year) regardless of the employee’s W-4 tax rate.
- The Gross-up Method: The bonus is processed with grossed up wages. This method will increase the gross amount to offset the income taxes for Social Security, Medicare, Federal, State, and Local taxes, so that the employee’s net bonus amount is a flat amount.
Example of Using the Gross-up Method
Gross-up is an extra payment that is made by an employer to cover the additional income taxes required to be paid out of a bonus, including Social Security, Medicare, Federal, State, and Local taxes.
For example, of an employer wanted to provide an employee with a bonus that had a net (take home) amount of $1,000 they would follow these four steps:
- Add together all applicable tax rates.
- Federal Supplemental tax rate = 22%
- Social Security tax rate = 6.2%
- Medicare tax rate = 1.45%
- State Supplemental tax = 4.9% (in Utah)
- Total = 34.55%.
- Convert the tax rate into a decimal, so 34.55% = 0.3455.
- Subtract the decimal tax rate from 1 (1 – 0.3455 = 0.6545).
- Divide the net pay by 0.6545 (1,000 / 0.6545 = 1,527.88).
Therefore, for the employee to receive a bonus amount of $1,000., the total grossed-up bonus pay from the employer should equal $1,527.88.
If you are considering paying any type of bonus to your employees, it is important to understand the different types and options for taxation. Complicated pay situations are the specialty of the payroll and HR experts at Helpside. If you have questions about bonus payments, please reach out to us at email@example.com.