Let’s look at the ways the IRS figures tax withholding on bonuses.
What is the bonus tax rate?
The IRS has a category called "supplemental wages" that includes severance pay, back wages, vacation payments, moving costs, overtime, taxable benefits, commissions and bonuses.
The reason for categorizing income is so it can be treated differently for income tax withholding purposes. The IRS and your employer treat bonuses in three different ways.
The Percentage Method
The IRS says all supplemental wages should have federal income tax withheld at a rate of 22%. So for a $10,000 bonus, you would have $2,200 withheld in federal income taxes and receive $7,800.
Your employer most likely will withhold this percentage from your bonus, because this is the simplest method. Fortunately, it is also the most beneficial to you.
The Aggregate Method
When your bonus is included in your regular paycheck, things get complicated. First, the normal withholding amount for regular income is calculated on the entire paycheck. Then the employer figures what was withheld from your last paycheck and subtracts that from your current withholding. The rest is withheld from your bonus.
This results in a higher rate of withholding on your bonus, and you may receive less of it simply because of the method used to calculate withholding.
How Bonuses Over $1 Million are Taxed Differently
Your bonus amount below $1 million must have 22% withheld, as mentioned. The amount above $1 million, however, is currently subject to withholding at 37%.
Strategies you can use to retain more of your bonus
Your best strategy is to ask for the bonus in a separate check from your salary. Then ask your employer to use the IRS supplemental wages rate of 22%. The employer will be in compliance, and you will get more money.
You could also request that the bonus be given to you after the end of the year. This can be advantageous if you think you will make less money next year, and your tax rate could be lower. If the aggregate method is used on your bonus, you will still have less taxes withheld if you are in a lower tax bracket.