Ashley Explains E05: How Bonuses & Commissions are Taxed (VIDEO)

Welcome to the next episode of "Ashley Explains," where our resident tax guru, Ashley Hamilton, lays down the facts about tax!

In this episode, Ashley Explains how bonuses and commissions, a.k.a. "supplemental wages," are calculated differently from regular wages. 

Read the Transcript:

ASHLEY:
Bonuses and commissions fall into a category defined by the IRS as "supplemental wages." Because these wages are not paid at a regular frequency it's harder to tell how they should be taxed. The IRS gives you two ways to calculate federal withholding on these payments. The optional flat/mandatory rate method or the aggregate method. For supplemental wages up to and including $1 million, use the optional flat rate method, which is 22%.

For any supplemental wages over one million use a mandatory flat rate method which is 37%. An employee has no federal income tax withheld from regular wages. The employer must use what's called the aggregate method. The aggregate method is especially useful if the supplement payment is issued separately from a normal payroll check. The only exception is when the employee's yearly supplemental wages exceed one million dollars. In that case you revert back to the 37% mandatory flat rate.

Now, an employee may have no withholding if he or she claims enough allowances to cause no withholding. In this case, use the following steps to calculate withholding on the supplemental wages.

Step one: combine the supplemental wage payment with the wages paid during the current or most recent payroll period of the year.

Step two: determine the amount of federal income tax withholding as if the total of the two payments is regular wages using the employee's marital status, number of allowances and either the wage bracket method or percentage method.

Step three: subtract the amount already withheld from the current or last wage payment from the amount calculated in step two. This difference is the amount that must be withheld from the supplemental wage payment.

Again, this method cannot be used for employees with year to date supplemental wages in excess of $1 million. Then, the 37% mandatory flat rate must be used. When the supplemental and regular wages are treated as if they were the regular wage payment without any indication that they are two separate payments, the employer must withhold federal income tax as if the employee usually earns this amount. when calculated in this way the result may be higher federal income tax withholding for the employee. 

Got any tax questions you would like Ashley to explain?

Email her at ashleyexplains@completepayroll.com