Are Bonuses Taxed in California? What You Need to Know
Understand how bonuses are taxed in California, including withholding methods, residency considerations, and employer requirements.
Bonuses are a common way for employers to reward employees, but many are surprised by how much is withheld for taxes. In California, bonuses are taxed differently than regular wages, which can significantly impact take-home pay.
Supplemental Wages Classification
Bonuses fall under supplemental wages, which include compensation paid in addition to regular earnings. The California Employment Development Department (EDD) and the IRS classify these separately from standard wages, leading to different tax treatment. Other examples include commissions, overtime, severance, and certain employer-issued awards.
This classification affects tax withholding. Regular wages are taxed based on an employee’s W-4 elections, while supplemental wages are subject to a flat withholding rate or combined with regular earnings for tax purposes. California mandates a 10.23% state withholding rate on supplemental wages. Federally, the IRS applies a 22% flat withholding rate on supplemental wages up to $1 million, increasing to 37% for amounts above that threshold.
Withholding Methods
Employers use two primary methods to withhold taxes on bonuses: the percentage method and the aggregate method.
The percentage method applies a flat withholding rate. In California, this means a mandatory 10.23% state income tax withholding, separate from federal withholding. The IRS requires a 22% flat withholding rate for federal taxes. This method simplifies tax calculations and provides a clear estimate of after-tax earnings. Employers favor this approach because it does not require factoring in an employee’s W-4 elections.
The aggregate method combines the bonus with an employee’s most recent regular paycheck and applies standard tax withholding rules based on W-4 elections. This often results in higher initial withholding since the bonus is treated as if it moves the employee into a higher tax bracket. While this reduces take-home pay temporarily, any excess withholding can be refunded when the employee files their tax return. Employers typically use this method when bonuses are included in regular paychecks rather than issued separately.
Residency Status
California taxes residents on all income, regardless of where it was earned. A California resident must pay state taxes on a bonus even if it was paid by an out-of-state employer or for work performed elsewhere.
Nonresidents are taxed only on income sourced within California. A bonus tied to work performed in the state is subject to California taxes, even if the recipient has since moved. This rule impacts employees who relocate mid-year or work remotely for a California-based employer. The state considers where services were performed and where the employer operates to determine tax obligations.
Part-year residents must file a part-year resident return (Form 540NR) and report only income earned while living in California. Bonuses received after leaving may still be taxable if they were earned for work performed while the employee was a resident. Disputes often arise over sourcing rules, particularly when bonuses are tied to long-term performance or vesting schedules.
Employer Withholding Requirements
Employers must comply with strict payroll tax regulations when issuing bonuses. They are required to withhold and remit income taxes, along with other payroll obligations. Failure to do so can result in penalties, interest charges, and audits from agencies such as the EDD and the IRS.
In addition to income tax withholding, employers must account for payroll taxes, including State Disability Insurance (SDI) and Unemployment Insurance (UI). SDI is withheld at 1.1% on wages up to $153,164 for 2024 and funds benefits for workers unable to work due to illness or pregnancy. UI is employer-paid and not deducted from employee wages, but misclassification of earnings can affect required contributions.
Employers must report all bonus payments on employees’ W-2 forms and submit payroll tax filings, such as the Quarterly Contribution Return and Report of Wages (DE 9) in California. Errors in reporting, such as failing to distinguish supplemental wages from regular earnings, can create discrepancies in tax filings and lead to scrutiny from tax authorities.