How Much Are Bonuses Taxed in Alabama?

Receiving a bonus provides additional funds beyond regular earnings. While a bonus is a welcome addition, it is not exempt from taxation. Both federal and state governments consider bonuses taxable income, meaning a portion will be subject to various taxes. Understanding bonus taxation is an important step for effective financial planning, allowing individuals to anticipate the net amount they will receive.

Federal Taxation of Bonuses

The Internal Revenue Service (IRS) classifies bonuses as “supplemental wages,” which are payments an employee receives in addition to their regular wages. These can include overtime pay, commissions, severance, and awards. Employers typically use specific methods for withholding federal income tax from these supplemental wages.

One common approach for federal income tax withholding is the percentage method, often applied when bonuses are paid separately from regular wages. Under this method, a flat 22% rate is generally withheld for federal income tax on supplemental wages up to $1 million within a calendar year. For any portion exceeding $1 million, a mandatory flat rate of 37% is applied. This method offers simplicity for employers but represents a withholding rate, not an individual’s final tax rate.

Alternatively, employers may use the aggregate method, especially when a bonus is combined with an employee’s regular paycheck. With this method, the bonus amount is added to regular wages for the pay period. Federal income tax withholding is then calculated based on the combined total, using the employee’s Form W-4 information. The tax is then determined as if the combined amount were a single payment. The amount already withheld from regular wages is subtracted, and the remaining tax is withheld from the bonus.

Beyond income tax withholding, bonuses are also subject to Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare. For 2025, the Social Security tax rate is 6.2% for employees, applied to earnings up to a wage base limit of $176,100. The Medicare tax rate is 1.45% for employees, with no wage base limit. An extra 0.9% Medicare tax applies to wages exceeding $200,000 for individual filers, which employers must withhold.

Alabama State Taxation of Bonuses

Alabama treats bonuses as regular income subject to state income tax. Bonuses are integrated into an individual’s overall taxable income for state purposes, not taxed at a separate rate. Employers are required to withhold Alabama state income tax from bonus payments.

Alabama utilizes a progressive state income tax structure with three tax brackets, where rates increase with income. For 2025, the state income tax rates range from 2% to 5%. The first $500 of taxable income is taxed at 2%, income between $500 and $3,000 at 4%, and all taxable income over $3,000 is subject to a 5% rate for single filers.

For state withholding on bonuses, Alabama provides employers with options similar to federal guidelines. Employers can combine the bonus with regular wages and calculate withholding based on the employee’s Alabama Form A-4 and the state’s withholding tables. Alternatively, for supplemental wages, Alabama allows employers to use a flat 5% supplemental withholding rate. This flat rate simplifies calculations for these types of payments.

Alabama also offers standard deductions that can reduce an individual’s taxable income, indirectly affecting the net tax paid on a bonus as part of their total earnings. For 2025, standard deduction amounts vary by filing status, such as up to $3,000 for single filers, up to $5,200 for head of family, and up to $8,500 for married couples filing jointly. These deductions are applied to an individual’s total adjusted gross income.

Understanding Bonus Withholding

A common misunderstanding is that bonuses are taxed at a higher rate than regular wages. While the federal withholding rate for supplemental wages can be a flat 22%, this is a withholding rate, not the final income tax rate. Actual tax liability on a bonus is determined at the end of the tax year when an individual files their annual tax return, based on total income, deductions, and credits.

If an employer withholds more tax from a bonus than an individual’s actual tax liability, it typically results in a larger tax refund. Conversely, if too little tax is withheld, an individual may owe additional tax at tax time.

Certain pre-tax deductions can help reduce the taxable portion of a bonus. Contributions to retirement accounts, such as a 401(k) or traditional IRA, or to a health savings account (HSA), can decrease an individual’s adjusted gross income. This reduction in taxable income can lead to a lower overall tax burden.

To ensure withholding accurately reflects their financial situation, individuals should review their federal Form W-4 and any state-specific withholding forms, especially after receiving a substantial bonus. The IRS offers a Tax Withholding Estimator tool to assist in determining appropriate withholding amounts. Adjusting withholding can help prevent underpaying taxes, which could lead to penalties, or overpaying.