Among the many benefits provided to employees are year-end bonuses. Paying benefits and bonuses to employees is a way for employers to show appreciation to their employees and also retain the good ones. The job market is a bit tight and losing good employees to your competitors can happen overnight, which is why some companies offer more bonuses as a way to keep their employees in the business.

The amount of money offered as year-end bonuses vary from one business to the other. There are several things employers and employees must know about year-end bonuses as they prepare to give and receive these bonuses come the end of this year.

Are year-end bonuses taxable?

It is important to find out whether bonuses of all kinds are treated as regular income or are singled out for special tax treatment. According to IRS, which covers the reporting rules for employers, different types of incomes should be treated differently and bonuses are just an example of that. Bonuses are basically supplemental wages since they are paid as compensation in addition to the employee’s regular wages. But how are bonuses taxed?

It is important to note that bonuses are not taxed the same way as ordinary wages or salaries. There are basically two ways through which you can withhold taxes from your bonuses:

1. The percentage method:

In this method, a supplemental rate of 25% is subjected on all supplemental wages including bonuses. If for instance an employee receives a bonus amount of $5,000 25% of that will be taxed and he can enjoy the rest of the money. If this is the approach that is used then the amount of your bonuses will be singled out from the rest of your income and taxed directly. This is the method that most employers prefer to use because it is easy to tax all the bonuses at a uniform rate.

2. The aggregate method:

This method is used mostly when your employer pays your bonuses together with your regular pay. The normal withholding amount is then determined based on the IRS withholding tables for the sum of both amounts, subtract what was already withheld from your previous paycheck and then you can withhold the rest of the money from your bonus amount.

The aggregate method is not so popular because instead of the taxes being withheld at a flat rate of 25% for only the bonuses, the taxes are withheld at a much higher rate once your pay and bonus are combined. This method leaves you paying more on taxes for the same amount of income.

If on the other hand the bonuses and benefits given to employees exceed $1 million or more, the bonus amount will be singled out for higher taxes. This means that your employer must withhold 39.6% of the amount as well as well as the standard 25% of the amount below $1 million. Always note that any method can be used to withhold taxes from your bonuses at payout, therefore do not panic if any of the method is used.