A bonus is a payment that a business makes over and above the salary or wages that an employee is set to receive. Bonus programs are created at the discretion of the company and often award managers and executives based on the continuing success of the business. Companies withhold taxes from bonuses in different ways than normal payroll. Many tax laws regarding bonuses change from state to state, with the two primary options being a percentage method and an aggregate method.
The percentage method creates a flat fee for taxing the bonus amount as supplemental income. Supplemental income falls under a slightly different income category than normal wages, and the IRS has a flat withholding fee for it that can range based on total income, but is often between 25 and 28 percent of the bonus. This requires the employee to withhold that much for taxes, in addition to common state-based withholding requirements.
The aggregate method does not assume a flat rate for the bonus. Instead, it tries to treat the bonus as much like normal income as possible. The employer may add the bonus payment to the last paycheck in order to automatically use the aggregate method, balancing tax withholding between the bonus paycheck and the latest regular paycheck. Other employers may treat the bonus as an entirely separate payment but still withhold taxes using standard withholding tables, essentially treating it as an additional check.
Based on which legal options employers choose, taxes for the bonuses will be withheld differently. This does not mean that the income from bonuses will be taxed differently: There is a key difference between the amount withheld and the taxes paid. From the perspective of the employee, taxes will remain relatively unchanged. Based on the employee tax bracket, income tax will be calculated and collected. If any of the amount withheld from the bonus goes beyond this collected amount, it will be automatically returned as a refund.
In other cases, employees may actually withhold too little from bonuses. This occurs with the percentage method. Sometimes an employee may receive a bonus large enough that it bumps him into a higher tax bracket. If the employee is taxed for the bonus at 25 percent but actually falls into a 30-percent income tax rate bracket, the employee owes an additional 5 percent in taxes on the bonus amount.