As December 31 creeps closer, some employees are wondering what Santa will leave in their payroll stockings. Visions of huge bonuses – like the $10 million in bonuses to be paid to the 198 employees of Baltimore-based St. John Properties – may be dancing in their heads. But statistically, most bonuses and gifts are modest, if at all.
Still, a gift (or a bonus) is an excellent way to wrap up the year. But what does it mean for employees?
If you receive a bonus or award from your employer – no matter how it’s paid out (cash, jewelry, or Bitcoin) – you must report it as income in the year that it’s received unless it’s expressly excluded (like some stock options). If, however, your employer promises to pay you a bonus in the future, you don’t have to report it until the bonus is made available to you, even if it’s in writing or otherwise spelled out. That includes a fixed promise to pay you a certain amount over time.
If you’re an employee, that income should show up with the rest of your compensation on your Form W-2. That’s because it’s taxed the same. There’s no surtax on bonuses for most taxpayers, despite what you’ve heard around the water cooler. A bonus could push you into a higher tax bracket, but remember that the U.S. has a progressive income tax. That means the higher tax rate would only apply to the amount over the bracket threshold (for a quick refresher on progressive rates, click here).
When you are paid, whether it’s regular pay or a bonus, your employer is required to withhold federal income tax. That’s no surprise. But the Internal Revenue Service (IRS) may consider your bonus as “supplemental wages” for purposes of withholding. If that happens, the amount of withholding may be at a higher rate than your regular income tax bracket.
The rules that apply to supplemental wages can be complicated but can be split along income lines:
- Those who receive more than $1 million in supplemental wages during the tax year; and
- The rest of us.
Since I suspect there are more of “the rest of us”, I’ll tackle that first.
- If your bonus is paid together with your regular wages – for example, a single check – your withholding occurs as it would with any other check. In other words, it’s treated as regular payroll.
- If your bonus is paid separately from your regular wages or if it’s paid together but noted separately – for example, a single check with the split specified in writing – your employer has a little flexibility. The employer can either withhold a flat 22% (the easiest option) on your bonus or figure the withholding amount using a more complicated formula based on your regular and combined withholding amounts. The latter, more complicated option tends to result in a higher withholding amount for most taxpayers.
What if you receive more than $1 million in supplemental wages during the year? First of all, awesome. But when it comes to taxes, the amount that exceeds $1 million is subject to withholding at 37% or the highest rate of income tax for the year (you can see the 2019 rates here). The amount under $1 million is subject to the same rules as the rest of us, as above. It doesn’t matter what’s on your form W-4. For the amounts under $1 million, the regular supplemental wages apply.
These rules apply to federal income tax. No matter which withholding rules may apply, the regular payroll tax rules for Social Security and Medicare still apply.
Confused? Don’t be. Even though the withholding may vary, your bonus will be treated at tax time as though it was regular compensation (some limited exceptions apply). So, whether your employer withholds 22% or 28% on your bonus, if your tax rate is 25%, you’ll pay 25% come tax time. If your employer withheld too much, you’ll get the difference back in the form of a tax refund. If your employer withheld too little, you’ll have to pay the difference.
It’s important that your employer gets it right – and crucial that you check your withholding – but there’s no need to panic. If the amount of tax withheld for the year is not enough, you can make an estimated tax payment. There’s still time to get it right: the deadline for making a payment for the fourth quarter of 2019 is January 15, 2020.
What if, instead of a bonus check, your employee hands you a gift? Cash is always taxable, as are cash-equivalent gifts like gift cards.
What’s wrapped in that box may also be taxable, depending on the content. Non-cash gifts to employees are not considered gifts: no matter what you call it, a non-cash gift to an employee is considered compensation. That means it’s reportable and taxable.
There is an exception for small non-cash gifts which are considered de minimis. De Minimis is Latin for “you’re not getting a real gift.” Okay, maybe not. It really means “of minimum importance” or “trifling” which, quite frankly, sounds worse. But if your employer provides you with a product or service and the cost of that product or service is so small that it would be unreasonable to account for it, the value is not considered income and it’s not taxable. So, a fruit basket or box of chocolates may be considered de minimis (and thus tax-free) but a Rolex watch? Not so de minimis (and thus taxable).
If you have questions about whether your year-end gift or bonus is taxable, check with your Human Resources (HR) folks or your tax professional – or both.