A bonus is a special payment given to someone as a reward for good work or achievement. The bonus is an additional payment to an employee beyond their salary or hourly pay.
Bonuses are deductible to your business, in the tax category of “payments to employees.”
Bonuses are not considered deductible expenses for sole proprietorships, partnerships, and limited liability companies (LLCs). Owners/partners/members are considered by the IRS to be self-employed.
Employee bonuses are always taxable to employees as an employee benefit, no matter how or when they are paid. Bonus payments are subject to federal income tax, Social Security tax, Medicare tax, and applicable state taxes.
If the employer delivers the bonus as part of the regular paycheck, it will be taxed like regular income. If it’s delivered with a separate check, it’s taxed as supplemental income.
If you pay the employee a bonus in a separate check from their regular pay, you can calculate the federal income tax withholding in one of two different ways:
- You can withhold a flat 22%.
- You can add the bonus to the employee’s regular pay and withhold as if the total were a single payment.
It is usually less costly to have the bonus delivered as supplemental income rather than as an amount added to the regular check. However, which approach will result in lower taxes depends on each individual situation.
If you aren’t withholding taxes from the employee’s paycheck (maybe because the employee claims an exemption from withholding), you must add the bonus amount to the employee’s current paycheck and figure the withholding as if the regular paycheck and the bonus amount are one amount.
One of the most effective ways to reduce taxes on a bonus is to reduce your gross income with a contribution to a tax-deferred retirement account. This could be either a 401(k) or an individual retirement account (IRA). The amount you donate to the retirement account, subject to limitations, reduces your taxable income so you’ll owe less.
You can’t get a deduction for a contribution to a Roth IRA.
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