The tax rate on bonuses and commissions means you can expect the IRS to take a chunk of these supplemental wages. The Tax Relief Center will talk about the tax rate on bonuses and what you can do to save on taxes, so you can enjoy your financial windfalls more. Read on to find out more.
RELATED: How to Negotiate with the IRS
In this article:
- Are Bonuses Tax-Free? And Other Questions on Tax Rate on Bonuses
- Supplemental Wages Defined: The Key to Understanding Tax on Bonuses
- What Is a Commission?
- What Is a Bonus?
- Are Bonuses Taxed Differently Than Commissions?
- Tips on Saving Taxes on Bonuses and Commissions
The Lowdown on the Tax Rate on Bonuses
Are Bonuses Tax-Free? And Other Questions on Tax Rate on Bonuses
It is this time of the year the question “Are bonuses taxed differently than commissions?” lingers at the back of everyone’s minds.
Some may also ponder about the question “How are bonuses different from commissions in the first place?” Or, “Why are commission checks taxed at a higher rate?”
To put an end to these nagging questions, let’s explore and answer them in this article.
Supplemental Wages Defined: The Key to Understanding Tax on Bonuses
For the purposes of learning about IRS tax on bonuses, the Internal Revenue Service considers bonuses and commissions as supplemental wages.
What does this mean? Supplemental wages are compensation paid on top of an employee’s regular wage.
These are severance or dismissal pay, vacation pay, back pay, moving expense, bonuses, commissions, overtime, and taxable fringe benefits. Because of this, the IRS treats bonuses and commissions (as other supplemental wages) differently from ordinary salary income when it comes to tax withheld and payout.
The question still hangs: are bonuses taxed differently than commissions? Before we get to the answer it would help to define these two first.
What Is a Commission?
A commission is a payment an employee receives based on the sales he brings to a company. Employers give their employees commissions to motivate and potentially increase their performances further.
Some workers receive commissions only without a base pay, others receive them on top of their salaries.
What Is a Bonus?
Companies give a bonus as a reward to an employee who has met company goals or has shown exceptional performance. Businesses usually give bonuses as a way to thank their employees for the impact their contributions bring to the organization (You can use this bonus tax rate calculator here to help with your computation).
Are Bonuses Taxed Differently Than Commissions?
The IRS has set two methods on how it taxes supplemental wages.
1. The Percentage Method
The IRS has a specified supplemental rate of 25%. This means that supplemental wages like bonuses and commissions should be taxed at that rate.
If you received a $3,000 bonus or commission, for example, the IRS should receive $750 of tax. Under this method, the IRS singles out bonuses and commissions from the rest of an employee’s income and taxes them directly.
Employers often choose this method because taxing commissions or bonuses at a uniform rate is easier.
2. The Aggregate Method
The IRS uses this method when you receive your bonus or commission with your regular salary.
Basically, the IRS bases your withholding tax on the sum of the two. They’ll then subtract the amount already withheld from your last salary and withhold the rest from the bonus or commission.
The problem with this method is that employees are more likely to end up with higher tax obligations. Unlike the simpler percentage method where the IRS will only withhold 25% from the bonus or commission, it’s almost always certain that one will incur a higher rate on both the normal pay and the supplemental wage.
Tips on Saving Taxes on Bonuses and Commissions
Obviously, receiving bonuses and commissions are for sure motivating. But admit it or not, seeing a big chunk of it sliced off to be taxed is pretty upsetting.
Here are five things you can do to offset the tax rate on bonuses:
1. Defer Your Bonus to Lower Tax Rate on Salaries
Bonuses and commissions will tip you over to the next higher tax bracket if you’re already sitting at the top of your current one. You can minimize the impact of your bonus on the tax rate on your pay by asking your employer to give you your December bonus in January instead.
2. Lump or Separate Your Bonus or Commission with or from Your Pay
You can lump or split your bonus from your pay depending on whether your salary is above the 22% tax bracket.
If your salary is well below the 22% bucket, you’ll definitely pay more taxes on bonuses if your employer separates them from your gross pay. Your best bet for this is to lump your supplemental wages with your withholding tax.
On the other hand, if your salary has risen beyond 22%, you can ask your employer to separate your bonuses and commissions from your pay. This way your supplemental income will not bear the brunt of your higher withholding tax rate.
3. Donate to Your Favorite Charity
Charitable giving will award you with tax deductions to offset the taxes on top of your bonuses.
Although the Tax Cuts and Jobs Act of 2017 capped deductions to $12,200 for single filers and $24,400 for joint filers, you can still use charitable contributions if you need tax deductions.
4. Deposit in Your Health Savings Account
A health savings account allows you to fund your future medical expenses and write off the amount you deposit from your taxable income. This is a good strategy to secure your health in the future and to save money on taxes in one payment.
5. Put Funds in Your 401(k) Plan or Your IRA
You can stretch your bonuses and commissions a long way when you deposit them into your 401(k) or IRA plan. You can contribute as much as $18,500 on your 401(k) and as much as $5,500 ($6,500 if you’re above 50 years old) on your IRA plan per year.
The great thing about this it allows you to write the $18,500 or $5,500 off of your taxable income on top of your $12,200 standard deduction cap.
The tax rate on bonuses and commissions will blunt the positive impact of your supplemental wages and even increase your tax liability if you’re already in the upper rung of your tax bracket. Stretch the value of any financial windfall beyond the short term by understanding how they’ll impact your taxes and where you can invest them so they’ll serve as your cushion when the time comes.
Do you have any other questions on how bonuses and commissions are taxed? Let us know in the comments section below.
If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.
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Editor’s Note: This post was originally published on December 5, 2017, and has been updated for quality and relevancy.