Does Gross Wages Include a Bonus? Here’s How They’re Taxed
Navigate how bonuses factor into your total gross wages and their specific tax treatment for payroll.
Employee compensation involves various forms of payment. Understanding how different types of compensation are categorized and taxed is important for financial planning, including regular pay and bonuses.
Components of Gross Wages
Gross wages represent the total amount an employee earns before any deductions or taxes are subtracted. For instance, regular pay, whether hourly or a fixed salary, is a primary component of gross wages.
Overtime pay, earned for hours worked beyond standard limits, also contributes to gross wages. Commissions, which are earnings based on sales or performance, and reported tips, particularly in service industries, are additional elements. Importantly, bonuses and other incentives are consistently included in gross wages as well.
Gross Wages and Net Pay
The distinction between gross wages and net pay is important in payroll. Gross wages are total earnings before any withholdings, while net pay, often called take-home pay, is the amount an employee actually receives after all deductions are applied.
Common deductions include federal income tax withholdings, state income tax withholdings (where applicable), and Federal Insurance Contributions Act (FICA) taxes, which cover Social Security and Medicare. Beyond mandatory taxes, other deductions can also reduce gross pay, such as contributions to health insurance premiums, retirement plans like 401(k)s, or wage garnishments for debts. An employee’s pay stub shows both the higher gross wage amount and the lower net pay amount.
Tax Implications of Bonuses
Bonuses are considered taxable income by the Internal Revenue Service (IRS) and are subject to federal income tax, Social Security tax, and Medicare tax. The IRS classifies bonuses as “supplemental wages,” which are payments made in addition to an employee’s regular salary or hourly wages. While bonuses are included in gross wages, their tax withholding rules can differ from regular pay.
Employers have specific methods for withholding federal income tax from supplemental wages. One common approach is the percentage method, where a flat 22% rate is withheld for bonuses up to $1 million. For bonuses exceeding $1 million, a higher flat rate of 37% applies to the amount over $1 million. Alternatively, employers may use the aggregate method, which combines the bonus with regular wages and calculates withholding based on the total amount. Regardless of the withholding method used, the total amount of bonuses received during the year is combined with other earned income and reported in Box 1 of an employee’s Form W-2.