How to give employees bonuses without taxes? In order to avoid taxes on a bonus check, you might use the following methods. Bonus money is always welcome. Less enticing is finding out how much of that windfall you owe in federal and state income taxes.
It’s important to know how your bonus will be taxed so there are no surprises when it comes time to file your taxes. Learn how to make the most of your bonus money and increase your net worth by knowing what to expect when you receive that much-anticipated cheque in the mail.
What are the tax consequences of bonuses?
You will be taxed at a flat rate of 22 percent on your bonus if you receive it as a separate payment from your regular paycheck. Bonus taxes can be calculated using what’s known as the percentage method. It’s best to check your state’s tax rules before making a purchase.
The bonus will be taxed as regular income if it is included in a regular paycheck. Your normal tax withholding choices will be taken into account. Bonus taxes can also be calculated using this method, which is called the aggregate method.
Depending on your tax bracket, one of these options is better than the other. The percentage technique may be better for you if your tax bracket is higher than 22%. It may be advisable to use the aggregate technique if your tax bracket is lower. If you have a preferred method, you should let your employer know so that they can use it.
A flat tax rate of 37 percent will apply to bonuses that exceed $1 million in a calendar year if your bonuses are paid separately from your regular salary. The first $1 million will be taxed at a rate of 22%. Depending on your total tax position, you may be eligible for a tax refund if an excessive amount of taxes is deducted from your bonus income.
How are regular paychecks taxed?
Depending on the information you supply on your Form W-4, such as whether or not you are married and how many children you have, taxes are automatically deducted from your regular monthly paycheck. If you frequently owe money in taxes, you may want to request that an additional amount be withheld for federal or state purposes.
In addition, your employer is required by law to deduct 7.65 percent of your gross pay to satisfy Medicare and Social Security taxes. Those earning more than $200,000 in a calendar year are additionally subject to an extra 0.9 percent Medicare tax withholding from their wages. Extra taxes begin to accrue if a worker earns more than $200,000 in a calendar year and continues to do so through December 31st.
In addition, there is a cap on the amount of Social Security taxes that may be deducted each year. In 2021, the maximum benefit will be $142,800, and in 2022, it will be $147,000, as determined by Social Security.
Taxes on your bonus can be minimized in five ways
If you follow these tips, you may be able to reduce the amount of taxes you have to pay on your bonus check so that you can keep more of your hard-earned money. You should also pay attention to your overall tax situation, not just the amount of taxes withheld from your bonus.
1. Utilize deductions
A lot of possible tax deductions are available if you can itemize your deductions. Among the possibilities are:
- Your bonus amount may dictate how much charitable giving you can afford to do this year in order to maximize your tax savings through these deductions.
- If your medical costs are above 7.5 percent of your adjusted gross income, they can be itemized on your tax return.
- On a primary or second property, you can deduct mortgage interest on up to $750,000 of debt.
The standard deduction for married couples filing jointly is $25,100 in 2021 and $25,900 in 2022; for single filers, it is $12,550 in both years. The standard deduction may be preferable if your total itemized deductions are less than the standard deduction amount.
2. Increase 401(k) contributions
Bonus money can be put to use in this way, which may help to reduce the tax burden associated with this additional income. Depending on your unique situation and the time of the bonus payout, the optimum method and timing will differ.
In the event that you are not already contributing the maximum possible amount of money to your company’s 401(k) plan, you should consider using some or all of your bonus to do so. Those 50 and older can contribute an extra $6,500 over the standard amount of $19,500 in 2021. For those over the age of 50, the catch-up contribution limit is $6,500, and the total contribution limit is $20,500.
Traditional 401(k) contributions are a fantastic way to improve your retirement savings, and the tax advantages of pre-tax contributions are a bonus. If you’re unsure of how to go about this, go to your human resources or benefits department. Allowable contributions may be made immediately from the bonus payout by some firms. In the event that this is possible, figure out how much you can contribute in addition to the regular payroll deductions you already make.
There are other options, such as putting in more each pay period to increase your annual contributions and using your bonus check to offset this amount. Alternatively, you might use the funds to increase both your own and your spouse’s payments.
If you’re married and already making the maximum contribution to your 401(k), you might be able to utilize part of that money to increase your spouse’s 401(k) contribution (k). Additional pre-tax contributions and increased retirement savings will still benefit you. Your spouse will be responsible for making additional payroll deductions so that you can “front” the money until the bonus is received.
3. Increase traditional IRA contributions
Contributing to a traditional IRA account can help you reduce your taxable income from a bonus check. To offset the tax hit from the bonus, you can deduct these contributions before taxes are withheld from your taxable income.
A 401(k) plan, for example, may only be eligible for tax deductions if the participant’s income is below a specified threshold amount. For single taxpayers, the limit for 2021 is $76,000, and for married couples who file jointly, it is $125,000. Single filers can expect to pay $78,000, while married couples can expect to pay $129,000.
You can deduct up to $208,000 in 2021 and $214,000 in 2022 from your taxable income if you don’t have a retirement plan but are married to someone who does.
4. Increase HSA contributions
You can contribute to a health savings account (HSA) tax-free if you have a designated high deductible health plan (HDHP) as your health insurance. In 2021, you can contribute up to $3,600 as an individual and up to $7,200 as a family to your health insurance policy. For individuals aged 55 and over, there is an extra payment of $1,000. Contributions are capped in 2022 at $3,650 for individuals and up to $7,300 for families for those having individual and family coverage.
An HSA’s benefits include pre-tax contributions and the ability to save money for future years or even retirement if it isn’t needed for medical bills. In order to spend part of the extra money and reduce some of the tax burdens, you might increase your contributions to your Health Savings Account (HSA).
5. Have your bonus combined with your regular paycheck
Bonuses can be included in your regular paycheck at certain firms; others may do it only if you specifically request it. Here, the bonus will be taxed according to your standard withholding rather than the 22 percent statutory rate for supplemental income. It is possible to postpone a portion of one’s salary into a 401(k).
Bottom line
A bonus is always a good thing. Even though paying federal and state and local income taxes on a bonus isn’t as exciting as it sounds, it’s a requirement. There are a number of things to keep in mind when it comes to preparing for your tax bill.
Consider your overall tax situation when deciding how to handle bonus tax. Get the help you need whether you’re filing your taxes yourself, or hiring a tax professional, by reading our guide to the best tax software out there.
