The age of technology has also brought with it an age where people know their worth. They engage in learning new skills and activities to grow professionally. Employers find it hard to employ these people who have expertise in their jobs as they demand more salaries than what the company can give them. This causes the company to introduce a new system of providing incentives to attract employees to the job. Here, let’s know about the Tax on Signing Bonus.
The incentive we are talking about here is a Signing Bonus. It’s important to make the job opportunity appear attractive. Payment of this type of incentive to the employee happens either upfront or from under the table. A signing bonus is also called a Signup bonus or a hiring bonus as it is signed during the hiring process. It is a financial award given by the company to the employee who is highly skilled and has other job opportunities that he can choose from.
Today the main thing we will focus on is whether these Signing bonuses get taxed or not.
Are Signing Bonuses Taxed?
Signing bonuses are offered as additional incentives to make the job opportunity seem attractive. This will make the employee choose a job with the highest salary. But are these additional payments taxed by the IRS?
A signing bonus refers to additional payments made by the company to a particular person. The amount provided to the employee gets added to his/her overall yearly pay. Taxes get collected at the end of each year this causes the bonus money to get taxed as well. Therefore the IRS- Internal Revenue System taxes the signing bonus as well.
These signing bonuses can also be taxed based on the type of contract you sign with the company. If you sign a contract that explicitly states that the amount is taxable then your additional income will be taxed by the IRS. It can also depend on the state you are living in and the type of tax laws it follows. If you don’t live in the state from which you are getting the additional payments can also determine whether your additional income will be taxed or not.
How are bonuses taxed?
There are different ways a signing bonus gets taxed. Over here we’ll be discussing two ways through which bonuses get taxed. This often depends on the state you live in and the federal laws that the state follows. Every state has a fixed percentage for taxing the employee’s income which changes according to your income.
The two ways a signing bonus can be taxed are-
- Percentage Method
- Aggregate Method
Percentage Method
The percentage method is one of the most common ways the IRS taxes the signing bonus. In it, they additionally tax the bonus amount. The IRS in the United States considers bonuses as an additional income compared to the original salary of the person. Thus this additional income needs a different way of taxing it, than the conventional taxing system used for their original salaries. Every item gets taxed at the end of each financial year, during April. Thus this amount will also be taxed during the last month of a financial year but with a different tax percentage which will depend on the bonus amount.
The IRS has introduced a method called the Percentage Method where your additional bonus is taxed separately from your original salary. This method is also known as the flat rate method. In this method, the IRS taxes the bonus am out with a different percentage. This method is often considered the easiest way to calculate the tax payments of an employee.
Every time an employee gets paid he/she needs to save a certain amount from his overall salary to pay the taxes levied on them. The amount you need to save depends on the withholding rate that is set for your salary. Similarly, the IRS sets a different withholding rate for all the additional payments or the bonuses of the employees. The withholding rate for bonuses as fixed by the IRS is 22% of the bonus. In Addition to the tax, you also need to pay the Social Security Tax and a Medicare Tax on your bonus payment.
All those whose yearly bonus is equal to one million or below will have a withholding rate of 22%, as set by the IRS. But for everyone whose bonuses exceed one million, their withholding rate increases by 37%.
The Social Security Tax wage rate is 6.2%. So you need to withhold 6.2% from your total salaries to pay taxes. This tax has a wage cap and people who earn beyond this wage cap don’t need to pay more according to their salary. The wage gap for the year 2021 is $142,800 thus any person who earns more than the wage cap will need to pay $8,680 as their Social Security Tax.
An example of the Percentage method –
Suppose your annual earning is $ 800,000 and your supplement wage is $5000 then due to your total salary being less than 1 million the withholding rate will be calculated according to the 22%.
For the $5000 bonus, the withholding rate will be 22%.
Therefore, $5000 × 22% = $1100
The remaining bonus will be $3900.
For the overall salary which is less than one million the withholding rate will be 22%.
Therefore, $800,000 × 22% = $17,600,000
100
= $176,000
The remaining salary will be $624,000.
The total amount you need to withhold is $177,100.
Aggregate Method
This is the second method that your employer can use to measure your taxes for the additional bonus. This method doesn’t use a different percentage to measure the supplement wage, instead considers it as a part of the original salary of the employee. This method requires a lot of calculations and is thus very hard for employers. The employer would need to calculate the aggregate withholding rate of your salary. This withholding rate is evaluated by adding your bonus and your original salary. This method isn’t widely used by many employers.
The method will calculate your total withholding using the same rate that is used to calculate the withholding of your original annual salary. The only difference is, your supplement wage will get added to your original annual salary. Due to this your total withholding amount will increase and will in turn increase your taxes.
How can you find your total withholding amount?
The very first thing you need to do is add up your bonuses and your total annual salary. Let’s call it your total wages. Apart from this you also need to add up your personal allowances and Publication 15 to find your real withholding amount.
The withholding rate for the aggregate method is similar to the percentage method. You need to withhold 22% of your total earnings that includes the bonuses added to your annual income, for paying taxes if your total annual income is less than one million. But if your annual income by adding your bonuses to it is more than one million then you need to withhold 37% from your annual income.
Let’s understand this with an example-
Your annual income is $800,000 and you receive a $5000 bonus. Now the aggregate method demands us to add both of these incomes. Adding them gives us a total of $805,000.
Let’s calculate the amount you need to withhold from your total wages. As your total wage is less than one million, you need to hold 22% of your total wage to pay the taxes. Over here your employer will calculate your withholding amount by subtracting the last paycheck withholding amount and calculate the final amount.
You now would be wondering if you need to return your signing bonus when you leave so now let’s talk about it.
Returning your signing bonus when you leave
This depends on the company you are working for. When you join the company you need to sign a signing bonus contract which will include all the information about the refund and conditions for refund. A company might ask for a refund if you leave the company before completing one year. Over here you need to pay the total signing bonus back to your employer when you leave the company.
Why are Signing Bonuses taxed so high?
The real reason signing bonuses are taxed high is because the IRS- Internal Revenue System views them as different from your overall salary. This is because your overall salary is similar to every other employee in your office but the bonuses increase your salary and thus you need to pay higher tax because they are known as supplement wages.
Conclusion
Now you know why your signing bonus check has a reduced amount than your original bonus. You can even calculate your tax withholding by the methods mentioned above or through the IRS tax calculator which is available here- https://apps.irs.gov/app/tax-withholding-estimator. This will help you with your tax payments and you can get an idea about how much you need to save and how much you can invest for yourself.
