Why does my bonus at year end get taxed at a different rate?
Every year when I get paid a bonus, almost half of the bonus gets withheld for income taxes. My normal paycheck is never taxed at that rate. How do I stop that from happening?
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My best guess as to why this is happening is because the employer or payroll vendor extrapolates the tax amount owed as if you were being paid this amount for each of your normal pay periods. So for example if you typically get 00 gross (before tax) twice a month, and get a one time 00 bonus, the 00 will be taxed as if you were getting 00 gross twice a month.
I believe the best way around this would be to temporarily change your deductions only for this pay period in order to get the amount of money you expect to receive. Caution: By basically fiddling with your deductions here, you are in effect saying "I know what I'm doing, and by my calculations I will expect to pay X% of taxes, when I really want to pay Y% of taxes". If you don't know what you're doing or if you make a mistake in calculating your tax liability, you could end up owing the government money at tax time, plus penalties.
Tax payments are a sliding scale. Let's say your earn ,000. Typically you might pay no tax on your first ,000, 25% on the next ,000, 40% on any amount above that. (I'm picking numbers out of the air here).
Your employer works out how much they expect you to earn, and calculates the tax they withhold from you so that it's the same amount every period. So the amount of tax you pay on a regular payment is going to be something less than 40%, because it is averaged over all your payments.
However the bonus is extra. It's taxed at the marginal tax rate which is going to be 40%. That's higher than the average rate you are paying on the rest of your income. However the total amount of tax paid is going to end up right.
Incidentally tax deductions by your employer are usually calculated by your employer, not the IRS, who will know that you don't get the bonus every month.
Bonuses can be withheld (not taxed, as another answer pointed out) in one of two ways:
1) Treat it as a normal paycheck. Because the software they are probably using assumes you get that level pay throughout the year, it will withhold as if you were a much higher earner than you are.
2) Withhold a flat percentage of 25%.
State taxes are on top of that, and bonuses are also subject to social security and medicare taxes.
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