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Taxes

Year-end bonuses are coming: Don’t be surprised how they’re taxed

You may have been promised a certain bonus amount last year, but a chunk of it will go to Uncle Sam.

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Catherine Mcqueen | Moment | Getty Images

If you are expecting a year-end bonus from 2022, these types of bonuses are generally paid within the first few months of the new year — which means that cash windfall could be hitting your bank account any day now, if it hasn't already.

But while you were told a certain figure as your bonus, the amount you'll actually receive will be lower thanks to taxes. Below, CNBC Select breaks down how your bonus is taxed by the federal government and what to do with that extra cash.

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How your bonus is taxed

Because the IRS considers company bonuses "supplemental income," they are taxed just like any other income you make. Other types of payment that fall into the supplemental income category include commissions, overtime pay, tips, severance and payment for unused accrued time off.

Federal taxes can be held from your bonus in two ways: the percentage method or the aggregate method. (And keep in mind your bonus may be susceptible to state taxes as well, regardless of which method is used to withhold federal taxes.)

The percentage method

With the percentage method, you receive a separate bonus check versus having it added to your normal paycheck. On the federal level, bonuses up to $1 million are taxed at a flat 22%, while any bonus more than $1 million is taxed at 37%.

The aggregate method

With the aggregate method, your bonus is added to your regular paycheck. Since your regular pay and bonus pay are combined, the amount of tax taken out is on that higher lump sum because of the way your yearly salary, and therefore your tax bracket, is calculated in that paycheck.

A hypothetical example of how your bonus is taxed

Let's assume you're expecting to receive a $5,000 year-end bonus for 2022. If your employer uses the percentage method, that $5,000 is taxed at 22% and you receive a bonus check for $3,900.

Using the aggregate method makes things a bit more complicated. Let's say your yearly gross salary is $80,000 — bringing your standard biweekly paycheck to about $3,077 gross, assuming 26 pay periods. As a single filing taxpayer, your annual gross salary lands you in the 22% federal tax bracket.

Your boss gives you a $5,000 bonus, but pays it out using the aggregate method. That means your next paycheck would be $8,077 gross (your normal pay + your bonus). And while the bonus is just a one-time payment, your employer calculates your federal tax withholdings that paycheck as if you make $8,077 every paycheck. The assumption here is that your annualized income is higher than what it really is, explains Ryan Losi, a CPA at accounting firm PIASCIK. In other words, the aggregate method assumes you make a yearly gross of around $210,000.

So, for one paycheck only, your $8,077 is subject to a withholding rate of 32% (the rate that applies to a single filer who makes $210,000 a year) instead of 22% (the rate that applies to a single filer making $80,000 a year). The good news is that you may receive a refund from the IRS after you file your taxes to make up for the excessive withholding, but it means seeing less upfront money from your bonus.

For those receiving their 2022 year-end bonus in the first few months of 2023, think about ways you can offset that taxable income for when you file a return next year. For example, donating to charity or contributing to a retirement savings account both qualify as a tax deduction that can reduce how much you owe.

If you received your bonus pay in 2022, you can estimate your withholding before you file your tax return this year by using the IRS' withholding calculator. File your taxes for free with online tax services like TurboTax Free Edition*, CNBC Select's top pick for the best tax software.

*(according to TurboTax, about 37% of taxpayers qualify for this edition and it's available for Form 1040 + limited credits only)

TurboTax

On TurboTax's secure site
  • Cost

    Costs may vary depending on the plan selected - click "Learn More" for details

  • Free version

    TurboTax Free Edition. ~37% of taxpayers qualify. Form 1040 + limited credits only.

  • Mobile app

    Yes

  • Live support

    Available with some pricing and filing options

Click here for TurboTax offer details and disclosures. Terms apply.

What to do with a bonus from your employer

Although your bonus will be taxed, it's still a windfall of cash that can help bolster your savings. Given the current environment of rising interest rates, we recommend putting your bonus into a high-yield savings account where it can grow and remain accessible at a moment's notice.

The Lending Club High-Yield Savings offers one of the highest returns on your money and doesn't charge a monthly maintenance fee or require a minimum balance. You just need an initial $100 deposit to open the account.

LendingClub High-Yield Savings

LendingClub Bank, N.A., Member FDIC
  • Annual Percentage Yield (APY)

    5.00%

  • Minimum balance

    No minimum balance requirement after $100.00 to open the account

  • Monthly fee

    None

  • Maximum transactions

    None

  • Excessive transactions fee

    None

  • Overdraft fees

    N/A

  • Offer checking account?

    Yes

  • Offer ATM card?

    Yes

Terms apply.

For savers looking to travel this year, consider the Bask Bank Mileage Savings, which allows you to choose to earn American Airlines AAdvantage® miles. With the mileage savings account, savers earn 2.5 miles for every $1 saved annually. You can then use these miles for flights on American Airlines or any of its 20+ partner airlines. The accounts have no monthly fees and no minimum deposits.

Bask Mileage Savings Account

Bask Bank and BankDirect are divisions of Texas Capital Bank, Member FDIC.
  • Annual Percentage Yield (APY)

    Earn 2.5 American Airlines AAdvantage® miles for every $1 saved annually instead of interest.

  • Minimum balance

    None

  • Monthly fee

    None

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle *The 6/statement cycle withdrawal limit is waived during the coronavirus outbreak under Regulation D

  • Overdraft fees

    N/A

  • Offer checking account?

    No

  • Offer ATM card?

    No

Terms apply.

Pros

  • Earn American Airlines AAdvantage miles instead of cash
  • No minimum balance 
  • No monthly fees

Cons

  • No option to add a checking account
  • No ATM access

Bottom line

If you were told you would be receiving a year-end bonus for your work in 2022, don't be surprised once it arrives in your bank account in the coming days or weeks as a lower amount. Because bonuses are earned income, they are subject to taxes. Kudos to you, though, any extra cash is nice stashed in a savings account during this high-interest-rate environment.

Catch up on Select's in-depth coverage of personal financetech and toolswellness and more, and follow us on FacebookInstagram and Twitter to stay up to date.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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