Why year-end bonuses are shrinking after taxes
The Internal Revenue Service treats bonuses as “supplemental income,” which triggers a flat federal withholding rate of 22% for bonuses under $1 million. On top of that come payroll taxes, including 6.2% for Social Security and 1.45% for Medicare, along with state taxes, as per a USA Today report. Combined, total withholding typically lands in the 30% to 35% range.
How the IRS taxes bonuses as supplemental income
That can be a shock for workers whose regular tax rate is much lower. Workforce management software company Homebase noted “That 22% federal withholding might be higher than your…regular tax bracket,” adding, “If they usually pay 12%, seeing 22% disappear from their bonus stings,” as quoted by USA Today.
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Holiday spending makes the bonus shock worse
The timing of bonuses can make the sting worse. Kevin Knull, chief executive of TaxStatus, said many Americans spend during the holidays as if they will receive the full bonus amount, not the after-tax figure, as per the USA Today report. When the net payment arrives smaller than expected, the gap can cause financial strain.
A $10,000 bonus illustrates the problem clearly. After the 22% federal withholding, plus Social Security and Medicare taxes, the take-home amount drops to just over $7,000, before any state taxes are applied. Knull said, “That’s all immediately deducted and goes to Uncle Sam,” adding, “Somewhere around 48% of the population underestimate what they pay in taxes. Income taxes take a big bite out of paychecks,” as quoted by USA Today.
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When bonuses can push workers into higher tax brackets
Bonuses can also have longer-term tax implications. Experts warn that a large bonus could push some workers into a higher tax bracket if their income is already close to the threshold.
There is some delayed relief for certain earners. If the total tax owed on a bonus ends up being less than the 22% federal withholding, the difference will be refunded or applied to other tax liabilities when returns are filed. Bonuses are ultimately taxed as regular income, meaning workers may have to wait until they file their 2025 taxes next year to recover any excess withholding. On the other hand, if the actual tax owed exceeds what was withheld, workers will need to pay the difference.
Using retirement contributions to lower bonus taxes
Experts say there are ways to reduce the tax impact. Kay Bell of Bankrate noted that directing some bonus money into a 401(k) or IRA, if contribution limits haven’t been reached, can lower taxable income, as per the USA Today report. For 2025, the IRA contribution limit is $7,000, or $8,000 for those 50 and older. The 401(k) limit is $23,500, with catch-up contributions of $7,500 for most workers over 50, and $11,250 for those aged 60 to 63.
Others may consider deferring a bonus to the following year if they expect their income to be lower, potentially placing them in a lower tax bracket. Richard Pon, a certified public accountant in San Francisco said that, “However, even if your tax bracket doesn’t change year to year, some like receiving bonuses next year just to move the tax liability to 2026,” as quoted by USA Today.
Why non-cash bonuses may still be taxable
Bonuses don’t always come in cash, but non-cash rewards can also carry tax consequences. Pon said cash equivalents such as gift cards, gift certificates, and season tickets are generally taxable. In some cases, employers deduct the taxes from regular paychecks; in others, they “gross up” the gift by covering the taxes, which can significantly increase the employer’s cost. Checking paystubs is essential to see how such items are treated.
There are limited exceptions. Conduit gifts, such as cash or gift cards collected by parent groups and passed on to teachers, are not taxable because they do not come directly from the employer. Personal gifts from a manager, paid out of their own pocket, may also be tax-free, since they are not considered employer-provided compensation.
Certain small, non-cash items, like hams, turkeys, or occasional event tickets, may qualify as “de minimis fringe benefits” and are not taxed. However, Pon cautioned that gift cards intended to buy those items are often still taxable.
FAQs
Why does my bonus get taxed more than my regular paycheck?
Bonuses are taxed as supplemental income with a flat federal withholding rate.
How much of my bonus goes to taxes?
Total withholding often ranges between 30% and 35%.