Nearly 200 workers at a Baltimore real estate developer will be having the happiest of holidays: The average employee will get a $50,000 bonus.
St. John Properties announced last week that it would pay $10 million in bonuses to its 198 workers. The employees will be paid based solely on years of service.
The payment was made in celebration of the firm hitting a goal of developing 20 million square feet of space in eight states —a goal St. John had originally set in 2005.
The bonus payment is in addition to the firm's annual year-end bonus and other workplace benefits.
Your end-of-year windfall can also become a bonanza for the IRS, absent the appropriate planning.
"A large bonus brings up broader financial planning questions, which will be different for everyone based on the size of the payment," said Lyle K. Benson, CPA and founder of L.K. Benson & Co. in Towson, Maryland.
A flat 22% rate
It's one thing to properly figure out your income tax obligation — the amount to withhold — from your regular paycheck.
Paying the appropriate taxes on your bonus pay is a different matter.
The IRS considers bonuses to be "supplemental wages," so these are taxed at a different rate from your wages.
Your employer can choose to withhold the federal income taxes at a flat 22% or they may pay your bonus along with your salary and use the aggregate amount to calculate withholding.
"The first thing to do is to know the tax impact and try to get the withholding set at the right level," said Benson. "It's a block and tackling move."
Be aware that withholding a flat 22% might not be sufficient if your tax rate is higher than that.
If you fail to withhold the right amount of tax for the year, you could either owe the IRS or receive a smaller refund when you file your 2019 taxes in April. You could also face an underpayment penalty.
Normally, you must pay at least 90% of the income taxes you owe for a given year, or 100% of the tax liability from the prior year before you actually file, to avoid an underpayment penalty on your tax return.
The threshold is 110% if your adjusted gross income on that year's return exceeded $150,000.
Your tax bracket
An extra bonus of $1,000 might not be enough to shake up your taxes, but a five- or six-figure payment could boost your taxable income and throw you into a different income tax bracket altogether.
Consider that individuals at the highest income tax bracket — 37% — are subject to the highest levies on long-term capital gains.
There's also the net investment income tax of 3.8%, which applies to investment income if taxpayers have modified adjusted gross income over $200,000 if single or $250,000 if married and filing jointly.
Those same taxpayers face an extra 0.9% levy, known as the additional Medicare tax, on their wages and income from self-employment.
"Fully understanding the impact of the bonus on your income this year is very important," said Benson. "The only way to do it is to complete a mock return or a tax projection to work through the numbers."
While boosting your contributions to your 401(k) plan and other workplace accounts can help you reduce your taxable income, make sure that your steep bonus doesn't place you a special class of wage earners known as "highly compensated employees."
Workers who received more than $125,000 from a business in 2019 ($130,000 in 2020) or who owned more than 5% of the business at any time in the year are deemed highly compensated employees.
These employees face limits on the amount they can contribute to their 401(k) plans and other workplace accounts.
Donate to save
Now that the standard deduction has been roughly doubled to $12,200 for singles in 2019 ($24,400 for married-filing jointly), fewer people are claiming itemized deductions on their federal returns.
However, if you do itemize, consider bunching several years' worth of donations to your favorite charity so that you can claim a large deduction for doing so.
Just bear in mind, you're running out of time to make those gifts this year.
"The worst case scenario is that you have lots of income this year, you make the contribution next year, and you don't get the big benefit," said Benson.
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