Employers need any advantage available to them in order to attract and retain top talent. Above market wages and strong benefits are some of the top ways for businesses to stand out above the competition. Once a business is financial stable, providing bonuses to its’ employees covers both of these important categories. Handing out bonuses does come with some compliance challenges for employers. Let’s take a look on how to handle bonuses when it comes to payroll.
What is a bonus?
A bonus is any additional compensation that is provided to employees above their normal pay. This can be in the form of money, gift cards or other additional rewards that an employee does not normally receive. These can be given to employees when they preform their duties above expectation or as a gift around the holidays.
One benefit of providing bonuses to employees is improving employee morale. Happy and engaged employees are more likely to stay with their company. Additionally, a high workforce morale produces better end results for your business.
How to handle bonuses for payroll
There are two main ways to handle bonuses from a payroll perspective. First, you can add the bonus to your employee’s normal paycheck. This is known as the aggregate method. The bonus amount would be noted in the employee’s paycheck.
Below is an example of an employee paycheck with a bonus added:
The second way to do this is by processing a separate paycheck for the bonus. Employees would receive two paychecks the week of the bonus. This is known as the percentage method.
|Smith, John (Paycheck #1)|
|Smith, John (Paycheck #2)|
Calculating taxes on bonuses
When thinking of withholding payroll taxes on bonuses, you must first know which method your businesses is using. Are you paying bonuses with the percentage method or the aggregate method?
Withholding proper taxes with the percentage method is simple. The separate check associated with the bonus is taxed at a flat rate of 22% for federal income tax. Bonuses are also subject to FICA taxes and state income tax withholdings. Furthermore, employers are responsible for contributing to FICA, Federal Unemployment taxes (FUTA), and State Unemployment taxes (SUTA) on bonuses.
For those employees receiving bonuses over $1 million, the amount under $1 million is taxed at 22% and the amount over $1 million is taxed at 37%.
If paying the bonus in addition to an employee’s wages, use the aggregate method to calculate tax liabilities. This method involves a few steps to calculate federal income tax.
- First, calculate the amount of federal income tax to withhold on the entire amount (bonus plus regular wages).
- Next, calculate the amount to withhold on just the regular wages.
- Then subtract the second value from the first value to get the amount of taxes to withhold on the payroll.
Finally, if you would like your employees to receive a set amount after taxes, you must do a tax gross-up. This means that you increase the size of the bonus to account for payroll taxes. For example, if you want all employees to receive a $500 bonus after taxes, you must gross-up the bonus to a higher amount to account for those taxes.
If you need assistance with your bonuses around the holidays, contact our team today!
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