How Are Bonuses Taxed in California?

How your bonus is taxed in California depends on various factors, including whether your bonus is monetary or non-monetary. While large companies may give you an extra check at the end of the year, a small business may give you a store gift card or food. 

Whether you receive a bonus in the middle of the year for outstanding work or you get an annual holiday bonus, you should understand bonus income tax rates to avoid any unpleasant surprises come tax season. 

Are Bonuses Taxed in California?

Yes, California taxes bonuses. However, some bonuses may not be taxed and the withholdings for taxable bonuses can vary.

Are Sign-On Bonuses Taxed?

If you have recently joined a company, you may have received a sign-on or hiring bonus as an incentive. Companies can pay these in cash, stock options or a one-time lump sum. Today, sign-on bonuses have become more common, so it’s critical to understand how they get taxed.

A sign-on bonus falls under your marginal tax rate, so a portion of your bonus will go to the federal and state government. However, for tax purposes, incentive payments are not regular income and are subject to different rules. Your employer will report an incentive payment as “other income” on the 1099-MISC form rather than on your W-2. Income tax will not be withheld from an incentive payment, but when you file your tax return, it will be part of your taxable income. You also won’t need to pay Medicare or Social Security taxes on an incentive payment.

Are Cash Bonuses Taxed?

Yes, cash bonuses are taxed. Typically, employers award cash bonuses to an employee in a lump sum for good work performance. The IRS may consider your cash bonus to be supplemental income, and thus, you will be subject to the corresponding federal tax rate for supplemental income.

Do I Have to Report My Holiday Bonus on My Taxes?

December is a time for gift-giving, and to show gratitude for a profitable or successful year, some employers give their employees year-end bonuses. Before you figure you what you want to spend your extra cash on, keep in mind that the IRS will consider your bonus compensation, and therefore, taxable income.

How Much Are Bonuses Taxed?

Bonus taxation depends on whether they are supplementary income, part of your wages or non-cash bonuses.

Why Are Bonuses Taxed So High?

Many employees worry about higher taxation for bonuses. Though bonuses are often taxed at the same rate as earned income like a salary or wages, the percentage withheld for taxes tends to be greater for a bonus than for regular paychecks. Similar to commissions, the IRS may classify a bonus as supplemental income. Though employers should withhold payroll taxes on a bonus, some IRS rules also apply.

The withholding tax rate may be more than you’re used to because federal taxes on additional pay are subject to the highest applicable tax rate.

Is Your Bonus Part of Your Salary?

Typically, the IRS classifies bonuses as supplemental income and puts them in a separate bracket, as the bonus is a discretionary reward that constitutes a surprise to the employee. Even if you receive the same holiday bonus annually, the discretionary definition still applies, since your employer has no obligation to provide you with this amount.

On your W-2 form, your bonus should be in the “supplementary income” row, which shows appropriate withholdings. If you don’t find your bonus included here, your employer may have decided to classify your bonus as part of your wages. Whether your bonus is supplementary income or part of your wages affects whether you enter a higher tax bracket or are ineligible for specific tax credits or deductions, so it’s a crucial consideration.

If your bonus is compensation, it will be subject to the following tax withholdings.

• Medicare tax: Since you pay Medicare tax on all your compensation, another 1.45% will be deducted from your taxes.
• State income tax: California has a graduated-rate income tax, so how much you will spend on state income tax depends on the tax bracket you fall under. If your bonus bumps you up into the next tax bracket, you may pay more during tax season than you expected.
• Social Security tax: Currently, you will pay a tax rate of 6.2% for Social Security while your employer also pays a rate of 6.2%. 
• Federal income tax: If your bonus is supplemental income, you will need to pay a flat percentage to the IRS. 
• Retirement plan contribution: If your employer usually contributes a percentage of your wages to your 401(k), they will likely also withhold the same percentage from your bonus. Though this means you’ll have less of your money now, you’ll be building a bigger nest egg for retirement.  

If you are getting a bonus and have to pay taxes on the amount, the good news is you may get some bonus tax back after you file your taxes.

What Are Bonuses Taxed at When They Are Part of Your Wages?

If your bonus is part of your wages, you may have the opportunity to adjust your withholding for the period that includes your bonus. Doing so will allow you to keep more of your money. Alternatively, your employer may choose to incorporate extra money to account for a difference in withholding. Check with your accounting or HR department to review your options.

You can maximize your bonus by resisting the urge to spend it and contributing the amount to your 401(k) if allowed. If your employer has already contributed a portion of your bonus to your 401(k), ask whether you can increase the percentage as long as you stay within the yearly contribution limit. 

If you can’t contribute more to your 401(k), you may be able to contribute your bonus to a flexible savings account or health savings account, which can increase your health benefits and lower your taxable income. However, if you decide to take advantage of either option, ensure you can spend the amount before you lose the benefit.

Are Non-Cash Bonuses Taxed Differently?

Sometimes, you may receive a non-cash bonus, like a Christmas basket or a Thanksgiving turkey. Legally, these non-cash bonuses are typically de minimis benefits, or non-taxable fringe benefits. The exception to this is if your bonus is in a form that could convert to cash, like a gift card. In this case, you can claim a bonus on your taxes, as your gift will be a taxable benefit. 

If you are unsure whether your non-cash bonus is taxable, ask your accounting or HR department. Your employer should be able to tell you whether you have received a discretionary holiday bonus, a year-end award or a de minimis benefit.

What Are the Methods for Calculating Taxes on Bonuses?

Employers can use one of two methods to withhold taxes from your bonus — the percentage method or the aggregate method.

• Percentage method: With this method, your employer will withhold a percentage of your bonus, which tends to be the easier way to calculate taxes on bonuses. Employers tend to choose this approach if they pay the bonus separately from typical earnings. 
• Aggregate method: Employers may choose this method when paying a bonus with your regular earnings. Your employer will include your bonus on your W-4 to determine how much to withhold. With this approach, your employer may withhold more than you owe, so you’ll have a lower bonus payment and a refund after you file your return.

How to Report Bonus on Taxes

On your W-2, your bonus will be in your standard wages received from your employer. You’ll enter this amount on Form 1040 when you file your taxes. 

Does a Bonus Affect Tax Credits?

A bonus could bump you up into the next tax bracket, which could also affect your tax credits. Tax credits you may qualify for include:

• Saver’s credit
• Child tax credit
• Adoption credit
• Lifetime learning credit
• Residential energy credit
• Earned income tax credit
• American opportunity tax credit
• Child and dependent care tax credit

If you receive a bonus, you may no longer qualify for specific deductions or tax credits, so your tax refund may be lower than you expected. If you are uncertain how your bonus may impact your tax credits, you can speak with a consultant at SD Mayer & Associates.

Do You Get Bonus Tax Back?

Even if your employer aggregates your bonus with your paycheck and withholds taxes on the entire amount, it doesn’t necessarily mean you’ve lost money. Since tax rates can be higher for supplemental income than the tax rate on your total income, you could get some of your tax payment back as part of your refund.

How Can I Avoid Paying Taxes on My Bonus?

A windfall at the end of the year can spell trouble for you during tax season. Fortunately, if you approach your year-end or holiday bonus strategically, you can prevent your extra cash from blowing up your taxes or your holiday. Follow the tips below to maximize your bonus and save on taxes. 

1. Figure out Your Tax Bracket

Know what your tax bracket will be before planning to spend it. The current tax rates are as follows:

• 10% for a single individual with an income of $9,950 or less and $19,900 for married couples who are filing jointly.
• 12% for an individual with an income of more than $9,950 and more than $19,900 for married couples who are filing jointly.
• 22% for an individual with an income of more than $40,525 and more than $81,050 for married couples who are filing jointly.
• 24% for an individual with an income of more than $86,375 and more than $172,750 for married couples who are filing jointly.
• 32% for an individual with an income of more than $164,925 and more than $329,850 for married couples who are filing jointly.
• 35% for an individual with an income of more than $209,425 and more than $418,850 for married couples who are filing jointly. 
• 37% for an individual with an income of more than $523,600 and more than $628,300 for married couples who are filing jointly.

If getting a bonus will bump you into the next tax bracket, you may want to ask to receive the money in January so you can avoid increasing your tax obligation.

2. Determine Your Withholding

Whether your bonus is supplemental income or part of your wages will impact your tax rate. If the bonus is supplemental income, it will fall under a different tax rate. If your bonus is part of your salary, your employer may withhold taxes at the federal income tax rate. If your employer doesn’t withhold the correct amount from your paycheck, you could owe the IRS when you file your return. To prevent this, you can request an additional withholding or make an estimated payment.

3. Increase Your Savings

Additionally, you may want to put extra money toward your retirement plan. This strategy can increase your savings and cut down on your taxable income. Currently, the 401(k) contribution limit is $58,000. Speak with your employer and your accountant if you want to contribute more to your 401(k) to reduce your tax liability. 

Alternatively, you can also contribute to a traditional IRA or a Roth IRA. Contributing to a traditional IRA can allow you to defer the taxes you need to pay on your bonus. A Roth IRA works similarly to a traditional IRA, except you contribute after-tax dollars to a Roth IRA. That means you will pay taxes on your bonus, but when you reach retirement age, you can withdraw funds tax-free. Currently, the maximum contribution you can make to an IRA is $6,000 or $7,000 if you are age 50 or older.

If you have already reached your contribution limit for your 401(k) and IRAs, you may be able to contribute to your health savings account if you have a high-deductible health plan. When you contribute, you reduce your gross income by that amount. As an individual, your HSA contribution limit is $3,550. If you have coverage for your family, your contribution limit is $7,100.

4. Donate Strategically

Consult SD Mayer & Associates to determine how you can donate strategically to minimize taxes. If you plan to itemize deductions on your return, you may want to make a sizeable donation to a charity. You can also boost your deduction by giving a couple of years’ worth of donations within the same year.

Contact Our Tax Advisory Experts for Help

At SD Mayer & Associates, we offer personal tax planning to our clients in the Bay Area. Reducing your tax liability requires careful planning, specific tax knowledge and an understanding of your finances and goals. Our tax consultants can help you develop a money-saving strategy that preserves your wealth by using our extensive technical knowledge of tax laws and regulations. Some of the strategies we may apply to personalized tax plans include:

• Defer tax liabilities
• Contribute to a 401(k)
• Liquidate investments
• Consider stock options
• Make charitable donations

If you work in California and have received a bonus, contact us at SD Mayer about how this may affect your taxes.