Outrageous taxes on a bonus check?

General Questions
#1

My company has a policy that if you get someone hired, if they make it past the probationary period of three months, the person who referred them gets a check for $1500. Well, I did just that, and four months ago.

So after the awkward thing of having to go to human resources and tell them they were a month late on this check and then having a whole conversation about how the person in question came to the company, even they agreed that I directly recruited her.

I finally get the check today…and it’s for $870.75. That means a whopping 42% got removed for taxes. I talked to other people about this phenomena, and they tell me “Oh yeah, they always do that with bonus checks”. Now I don’t want to come across as greedy, but WTF? How is it that the tax rate on a bonus check is this high, and why? They even have a breakdown of all the taxes taken out. Why isn’t it treated like a normal paycheck at least?

Idiot that I am, I assumed this got treated like a tip and that I’d be getting a check for $1500.

#2

Well, (here in Canada) they add the Bonus into your regular wage for the month (week, whatever) and calculate the taxes on the total.

Assuming your monthly wage was $1500, and you got a $1500 bonus, making your total $3000, you would be in a higher tax bracket and have to pay more taxes.

You might get it back in April when you do your taxes.

#3

You did get paid $1500 less taxes of course. Just like if you take a job where you get paid weekly for $52,000/ year you are not going to get a check for $1,000 net each week.

Now here is the deal. Your $1500 bonus was withheld as if that was added into your regular check. In other words from a withholding point of view it appears that you got a $1,500 raise during this pay period. The good news is that at the end of the year your income is only $1500 above last year, and while that last $1,500 is taxed at a much higher rate than the first $1,500 you made it shouldn’t be taxed at 42%
You should see a good portion of the $1,500 back come tax time either in a larger refund or a lower tax liability.

Rick (who has been whacked over 45% on a 7,500 bonus)

#4

Yeah that happens at our place too. It is an IRS thing and it will equal out when you pay your taxes for 2003. This may help explain how the system works.

#5

I got a signing bonus when I started my job. And I’ve gotten a couple performance bonuses in the last year. All these were tacked onto a regular paycheck, and they got taxed like crazy.

I think I figured out the logic for mine, hopefully it applies to yours. When I got my signing bonus they plugged my gross pay for that first check into their tax formula, and withheld accordingly. They took out taxes as if that was a regular paycheck, and I would be getting 25 others like it that year. However, at the pace of that paycheck, I’d be making over $200,000 a year. Not too likely in the Federal Government.

When it came time to file my taxes, that over-withholding finally showed. I did some quick figuring with and without the effect of the bonus, and it turned out I got about about 90% of the excessive taxes back. It made for a hell of a refind check!

Since the payroll office could only compute that check as if I were on pace to make a quarter million dollars a year. That made them withhold at that tax rate, but it only turned out to be over-withheld because the rest of my paychecks were normal. If the bonus had been spread out over a year’s worth of paychecks, it wouldn’t have been taxed so heavily. But I also wouldn’t have the big tax refund, and therefore wouldn’t have the big TV in the living room. :cool:

#6

Congrats you just had a lesson on how much Unc Sam really takes, and it’s not on just your bonus check. There are deductions on your pay check you never see, but that doesn’t mean you don’t pay them. If you are ever self employed you will find that that amount is just about right.

#7

The answers so far about the paycheck being taxed as if you got that much every time are correct. If you don’t want to wait for a tax refund next year, you can always tweak your withholding for a paycheck or two so that you pay a bit less tax.

#8

I second alice’s suggestion. If they figure your bonus as a continuation or extension of your most recent pay, then you do not get the “discount” rate for the lower pays.

For example, (using the 2002 numbers), based on 26 pay periods a year and you being single (for simplicity), if your normal pay per period is $1,000, your Federal tax is 10% on the first $230 and 15% on the next $770. However, annualized, your $1500 bonus makes your single pay appear to be $65,000, so you pay 10% on the first $230, 15% on the next $845, and 27% on the final $2,040. The $1,500 bonus is calculated as all in the 27% range.

But wait!, you say, with a top of 27%, they can’t have 42%!
Well, now, in addition to that IRS tax, you also have FICA and state (and possibly local) taxes. California rates slide from 1% to 9.3% and I do not know what your city taxes are, but the FICA rate is 7.65% (so you were at 34.5% before we even consider state and local).

And, of course, if you are making more than $26,000 per year to begin with, (such that the $1,500 would make it appear that your annual rate exceeded $67,700) you would be paying 30% on whatever portion of that $1,500 appeared to push you above the 67K mark. If you’re already making 67K, the whole bonus would have been taxed at 30% by the Feds (although, by this time of year, your FICA might have been eliminated).

#9

What is this ‘bonus’ of which you all speak? :wink:

#10

Check what is coming out of your check. I did the incentive plan at my last company. They took, in addition to taxes, 401k, the i forgot what it is called…where you put money in to use for medical expenses, and stock options out of bonus money.

In fact I used to tell EVERYONE that in order to prevent this they had to STOP the deductions TWO weeks prior to getting the check, thus not only your bonus but your regular check as well stopped getting deducitons. Then after you got the bonus to start up the deductions. And since it could take two to four weeks to start them up sometimes you would miss a bunch of 401K payments.

#11

Please provide proof of this assertion. I ask because as far as I know, ANY deduction from your pay must be indicated on your pay statement.

#12

I am not 100% sure this is legal. I believe that in order to keep in compliance with regs regarding 401K, deductions must be taken from all earnings. If your company allows changes quarterly and you know your getting a bonus, you could technically stop your 401K deduction at the beginning of the quarter in which you are getting the bonus and then start up again after the bonus.

Depending on your personal retirement strategy, this may or may not be a good idea.

#13

Just a little nyah-nyah for you all. My company takes care of this little unpleasant surprise in a rather cool way. If, for example, I am promised a $1000 bonus for recruiting a new hire, the check will be cut for whatever amount is necessary to get me $1000 after taxes.

#14

If your company is allowing people to change their allocation to a Flexible Spending Account in the middle of the year for any reason other than a change in family status, they are setting themselves up for an audit and a big fat IRS fine since this is in violation of the rules governing Section 125 plans. You CANNOT change your allocation to a medical FSA or Dependent Care FSA during the plan year except when you have a valid change of status. Wanting to avoid having the funds taken out of your bonus is not a valid reason.

Depending on how the 401K is set up, it could well be possible to stop deferrals on one or more checks during the year. My plan allows as many changes in deferral percentage, stops, and starts as I want during the year. (We process changes every pay period - every 2 weeks.) If your plan allows changes quarterly, then you are free to stop deferrals in one quarter but you cannot start them again until the next entry date on the next quarter.

#15

Section 125 funds should be taken as a fixed amount per paycheck anyway, not as a percentage, so the bonus should not have anything deducted. You make an election of a total amount per year and it is taken in equal amounts per paycheck.

#16

Although I am not sure about that, amarone, it is certainly possible. Everything I’ve read words the procedure as, “An employee decides how much of their salary should be set aside before taxes are calculated. This amount is automatically deducted from the employee’s paycheck every pay period, just like any other payroll deduction, and is deposited into their FSA account.” I can’t find anything that says the total allocation is decided for the year and then divided into the number of paychecks. But it might well be that way.

My point was that an employee cannot arbitrarily decide during the year that he doesn’t want FSA deductions taken out of some certain paycheck(s), which is what it sounds like Markxxx is saying. Perhaps it is NOT taken out of a bonus check but it has nothing to do with whether the employee wishes this or not, and the employee cannot stop and then miss a few withholdings from paychecks while waiting to start up FSA deductions again.

#17

missbunny, your second paragraph is certainly correct. With respect to election amounts versus percentage, I have a form in front of me now. You enter the amount to be deducted per pay period and the plan year election amount, described as Pay Period Amount x # Pay Periods. You can download a form (pdf) from here.

From a common sense viewpoint, it has to be this way. Any unspent money at the end of the year is lost. If you used a percentage and an employee had a good year, e.g. some big sales commissions, it would be silly to force them to withhold medical expense amounts that they would then lose at year-end.

#18

Sure you would, had you chosen to save that spread-out bonus and use it to buy the TV (or bought the TV on time and used the spread-out bonus to make the payments). Refund checks aren’t some gift the government gives us. It’s the return of the money they took in excess of what they were owed.

#19

Monty, I believe what kanicbird is referring to is the so-called “self employment tax,” i.e. the half of Social Security and Medicare taxes that employers pay, which the self-employed must pay themselves. If that’s not terribly clear (sorry) here’s an explanation from the National Association for the Self Employed:

If you’re an employee, you never see a deduction on your paycheck for the 7.65% paid by the employer. Of course, the economic reality is that the 7.65% comes mostly out of your hide, anyway. From your employer’s persepective, it’s part of the personnel cost of employing you, so it really comes out of what they would have available to pay you in cash, were it not for the tax.

For people who start self-employment, that extra 7.65% that they suddenly have to pay themselves comes as a pretty brutal shock.

#20

This is called a “gross up” of the bonus amount. Your company, as you realize, is essentially paying the taxes for you so that you get more “in hand”.

The companies I’ve worked for typically do this for relatively small amounts, say anything of $1500 or less. It makes the bonus still valuable. It can be disconcerting (as it was for the OP) to be told it’s a $1000 bonus and you only get to take home $600.

It also sometimes depends on the type of bonus. A bonus as a consequence of some sort of Reward and Recognition program is usually grossed up. A hiring referral bonus is often grossed up. A performance bonus at the end of the year is usually not grossed up.

YMMV.