How to tax bonuses and supplemental wages correctly

Few payroll topics generate more confusion — and more employee complaints — than how bonuses are taxed. “Why was my bonus taxed so much?” is a question every payroll team hears. The short answer is that it’s about withholding, not the tax rate, and there are two accepted methods. Here’s how to run it right and explain it clearly.

What counts as supplemental wages

Supplemental wages are payments outside regular wages: bonuses, commissions, overtime in some contexts, severance, back pay, awards, and payouts of accrued leave. They have their own withholding rules, separate from a regular paycheck.

The two federal withholding methods

The flat-rate (percentage) method

If the supplemental wages are paid separately, or identified separately from regular wages, the employer can withhold federal income tax at a single flat percentage set by the IRS (currently 22%). It’s simple and predictable, which is why most employers use it for bonuses.

The aggregate method

If the bonus is combined with a regular paycheck and not identified separately, you withhold as though the whole amount were regular wages — using the employee’s W-4 and the normal tax tables. Because the combined amount can push into a higher withholding bracket for that check, this method often withholds more than the flat rate, which is where the “my bonus was taxed to death” feeling comes from.

The myth to put to rest

Bonuses are not taxed at a higher rate than other income. The flat 22% is a withholding figure, not the employee’s actual tax rate. When they file their return, the bonus is taxed like any other income at their real marginal rate — and if too much was withheld, they get it back. Explaining this to employees heads off most of the complaints.

Two things people forget

• FICA still applies. Social Security and Medicare come out of supplemental wages just like regular wages, on top of income-tax withholding.
• Very large bonuses have a mandatory higher rate. Once an employee’s supplemental wages exceed $1 million in a year, the amount above that must be withheld at the top income-tax rate (currently 37%), regardless of method.

Grossing up

If you want an employee to receive a specific net bonus — a clean $5,000 in hand — you have to “gross up”: calculate the pre-tax amount that, after withholding and FICA, leaves the target net. It’s common for signing and spot bonuses, and easy to get wrong by hand at scale.