Does Gross Income Include Bonus Payments?

Understanding Gross Income

Gross income represents the total earnings an individual receives from all sources before any taxes or deductions are subtracted. It serves as the initial figure for calculating an individual’s tax liability. Various forms of earnings are typically included, such as wages, salaries, tips, commissions, interest earned from bank accounts, dividends from investments, and income from rental properties or royalties.

This broad definition ensures that most forms of monetary benefit received are accounted for, unless specifically excluded by tax law. All income, regardless of its form, contributes to gross income.

Bonuses as Part of Gross Income

Bonuses are indeed included in an individual’s gross income for tax purposes. The Internal Revenue Service (IRS) views bonuses as additional compensation provided for services performed. This means that whether you receive a year-end bonus, a signing bonus, or a performance-based incentive, it is considered taxable income.

Even if a bonus is not paid in cash, such as a gift card or a vacation, its fair market value must be included in your taxable income. Employers report these bonus payments on your Form W-2, usually combined with your regular wages in Box 1.

How Bonuses Are Taxed

While bonuses are part of your gross income and ultimately taxed at your ordinary income tax rates, the way taxes are withheld from them can differ from regular wages. The IRS classifies bonuses as “supplemental wages,” a category that also includes items like commissions, severance pay, and overtime. Employers must withhold taxes from these supplemental wages, just as they do from regular paychecks.

Employers generally have two main methods for withholding federal income tax on bonuses. The first is the percentage method, also known as the flat rate method. Under this approach, if a bonus is paid separately or clearly identified, employers typically withhold a flat 22% for federal income tax on amounts up to $1 million. For any portion of supplemental wages exceeding $1 million within a calendar year, a higher flat rate of 37% is applied.

The second method is the aggregate method, which is used when a bonus is combined with regular wages in a single paycheck. In this scenario, the employer treats the combined amount as a single payment and calculates withholding based on the employee’s Form W-4 and standard withholding tables. This method can sometimes result in a higher initial withholding than the flat rate method, as it accounts for the overall increased income for that pay period. Regardless of the withholding method used, the bonus amount is added to your total income for the year and is subject to federal income tax, Social Security tax (6.2%), and Medicare tax (1.45%). Any over- or under-withholding will be reconciled when you file your annual tax return, potentially leading to a refund or additional tax due.