Many employees expect and depend on an annual bonus, usually delivered sometime around Christmas. Many companies distribute bonuses as a thank you for hard work and going above and beyond during the year. It’s win-win.
The tax department loves them, too. Bonuses ultimately count as taxable income, although how you calculate it can be a bit complicated and convoluted. In order to get a precise figure, it’s best to leave the calculations to a certified professional accountant/tax advisor, or to use a quality tax program like TurboTax, H&R Block, or Ufile.
If you simply want a solid ballpark figure, there are some basic calculations you can make yourself for determining tax on a bonus in either Canada or the United States. These are meant only as a guideline and do not constitute 100% accurate stats and figures.
The United States
At the end of the day, the IRS considers all income the same. There are two basic methods, though, if you’d like a rough estimate on the amount of tax you’ll owe on a bonus.
#1 The Percentage Method.
This one is the infinitely easier of the two. The percentage method - as the name implies - requires taking a straight 25% deduction from the total bonus amount. So, for example, if you received a one-time bonus of $2500…
$2500 x 25% = $625
You would owe $625 on your bonus. You may also have to pay an additional 1.45% Medicare tax, and 6.2% Social Security tax as well. Finally, if you’re incredibly fortunate, be aware that the tax rate increases to 35% on any amount over $1 million.
#2 The Aggregate Method
Much. More. Complicated. This method involves adding together the bonus and amount of your most recent regular paycheck. Check for the standard IRS withholding amount for that new sum using the regular IRS tables. Next, subtract the amount that was withheld from your last regular paycheck. The leftover difference is the amount owing on your bonus.
The percentage method usually (though not always) works out better in your favour. You can quickly compare the two methods using a free Bonus Tax Calculator.
To determine the amount owing on a bonus paid in Canada, you need to do a bit more math.
Start by utilizing the Periodic Method (used to calculate for regular payments).
- Calculate your pay period amount (the regular salary you receive each time you are paid. Usually biweekly or monthly). Multiply this figure by the number of pay periods (biweekly = 26, monthly = 12). So, for example, if you receive $1500 every two weeks, it would be $1500 x 26 = $39,000.
- Determine the tax owing on that amount (minus the basic deductions) using the current tax rate ($0-$43,561 was taxed at 15% for 2013). Divide that amount by the number of pay periods.
- Set that number aside.
There is also what is referred to as the Bonus Tax Method, which is identical to the Periodic Method outlined above, but with one extra step.
- Calculate your regular pay period amount multiplied by number of pay periods (as above).
- Add in the bonus amount (for example, $2000).
- Calculate the tax owing on this NEW SUM (minus the basic deductions) using the appropriate tax rate (in this example, the bonus does not bump us to a new tax rate, so it’s still 15%).
- Divide the amount owing by the number of pay periods.
- Subtract the amount owing you calculated using the Periodic Method (above) from this Bonus Tax Method sum. The difference is the rough tax you owe on your bonus payment.
A bonus at any time is well received. Just make sure you understand the tax consequences, and then put that windfall towards something worthwhile. Bonus indeed. And check out How Does the Bonus Tax Method Work? for a more detailed and complicated explanation.