How Are Bonuses Taxed? Withholding Rules for Employers
Bonuses are withheld at a flat 22 percent or by the aggregate method. What that costs you, the overtime recalculation, and why 22 percent is not the tax.
How Are Bonuses Taxed?
The two withholding methods and which one to use, why the 22 percent everyone quotes is not a tax rate, what a bonus actually costs the business once payroll taxes are added, and the overtime recalculation on nondiscretionary bonuses that quietly creates back-pay liability at small companies
Every bonus payment I have ever run has produced the same message from at least one person: why did they take so much? The answer is short, it is reassuring, and almost nobody hears it before payday because nobody thinks to say it.
That part has a one-sentence fix. The part that actually costs money sits on your side of the ledger and does not appear in any of the consumer articles about bonus taxation: if the bonus was nondiscretionary (promised or formula-based) and went to non-exempt employees who worked overtime, you owe them more overtime than you already paid.
This guide covers the two withholding methods and which to use, why the 22 percent everybody quotes is not a tax rate, what a bonus really costs the business, and the overtime recalculation. I build the people and records tooling for businesses without an HR department at FirstHR, and FirstHR is an onboarding and HR platform rather than a payroll provider. This is general information, not tax advice.
The Short Answer
Bonuses are taxed as ordinary income, exactly like salary. There is no separate bonus tax and no penalty rate. What differs is how much is withheld at the moment of payment, and federal rules give employers two ways to calculate that.
One distinction the employee never sees shapes which method you can use: whether the payment was identified separately or blended into a normal paycheck. Blend it in, and the flat rate is off the table.
22 Percent Is Not a Tax Rate
The flat 22 percent is a withholding rate, not a tax rate: an estimate collected at the time of payment and reconciled on the employee's annual return like every other dollar withheld all year. It is the single most useful thing an employer can explain, and it takes one sentence.
| Employee’s marginal rate | Withheld at the flat rate | What happens at filing |
|---|---|---|
| 12 percent | 22 percent | Too much was withheld; the difference comes back as refund |
| 22 percent | 22 percent | Roughly correct |
| 24 percent | 22 percent | Slightly under-withheld; a small amount may be owed |
| 32 percent or above | 22 percent | Materially under-withheld; the employee may owe at filing |
The other half of the answer is that people add up every deduction on the pay stub, not just the federal one. Flat withholding of 22 percent sits on top of 7.65 percent for Social Security and Medicare, plus whatever the state takes, so close to a third of a bonus can disappear before anybody has been taxed at a high rate at all.
Over-withholding and under-withholding both produce complaints, and they are opposite complaints. Lower-paid employees feel robbed on payday and are made whole months later. Higher-paid employees feel fine on payday and are surprised in April. Saying which of these applies, before the money lands, is the whole of the fix.
The Two Methods
According to IRS Publication 15 (2026), federal rules give employers a choice between two ways of withholding on a bonus. The choice changes the employee's net payment without changing their annual liability.
The flat rate is only available where the supplemental payment is identified separately from regular wages. Adding a bonus to a normal paycheck line removes the option, which is a mechanical reason to give bonuses their own payment, or at least their own stated amount, rather than folding them in (26 CFR 31.3402(g)-1).
Publication 15 adds a second condition that is easy to miss. The flat rate applies only if federal income tax was withheld from the employee's regular wages in the current or the immediately preceding calendar year. Where it was not, the aggregate method is the only option.
Which One to Use
Where both methods are open to you, the percentage method wins for a small business on almost every dimension that matters.
| Consideration | Percentage method | Aggregate method |
|---|---|---|
| Ease of calculation | One multiplication | Depends on the last paycheck and the withholding tables |
| Predictability for the employee | High, and checkable | Low, and varies by pay period |
| Typical net to the employee | Higher | Often lower, sometimes substantially |
| Accuracy for a high earner | Under-withholds | Closer to the real liability |
| Questions generated | One, answered in a sentence | Several, and harder to answer |
| Requires the bonus to be stated separately | Yes | No |
The one genuine argument for the aggregate method is the fourth row: for a highly paid employee, flat withholding at 22 percent can leave a real bill in April. Where you know that is the case, the kinder move is usually to keep the flat method and tell the person plainly that they may want to set some aside, rather than to withhold more and explain why their bonus shrank.
Above One Million
Where an employee's supplemental wages exceed $1 million within a calendar year, the excess is subject to mandatory withholding at the highest individual rate, 37 percent for 2026 (26 CFR 31.3402(g)-1). This is not optional, and the aggregate method is not available for the portion above the threshold.
Two details catch employers who assume this only affects large companies. The threshold is cumulative across the year rather than per payment, so several smaller supplemental payments can reach it in combination. And it counts all supplemental wages, not only bonuses, which brings severance, commissions, and separately paid overtime into the same total.
Payroll Taxes Still Apply
Withholding rates get the attention and the employer cost sits underneath them. A bonus is wages, so the whole payroll tax stack applies: Social Security at 6.2 percent and Medicare at 1.45 percent on each side, with the Social Security half stopping at a 2026 wage base of $184,500 (IRS Topic 751).
The second cost on that list is the one that makes timing matter. Unemployment tax wage bases are annual, so a bonus paid in January to somebody who has not yet crossed them attracts tax that the same bonus paid in December would not. It is rarely the deciding factor, and it still belongs in the budget.
The number to approve is the bottom right of a sheet like this one, not the pool figure somebody said in a meeting. Price it per person, because the wage bases and the overtime exposure differ by employee even when the bonus amount does not.
| A | B | C | D | E | F | G | H | I | J | K | L | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 1 | Employee | Gross bonus | Discretionary or nondiscretionary | Non-exempt? (yes / no) | Withholding method (percentage / aggregate) | State supplemental treatment applied | Employer Social Security and Medicare (7.65%) | Federal unemployment tax still owed | State unemployment tax still owed | Overtime true-up owed | Total cost to the business | Pay date |
| 2 | ||||||||||||
| 3 | ||||||||||||
| 4 | ||||||||||||
| 5 | ||||||||||||
| 6 | ||||||||||||
| 7 | ||||||||||||
| 8 | Pool total |
The Overtime Recalculation
This is the part that turns a bonus into a wage claim, and it applies to non-exempt employees only. A nondiscretionary bonus must be included in the regular rate used to calculate overtime for the period the bonus covers, which means the overtime you already paid was calculated on too low a rate.
The correction is mechanical and set out in 29 CFR 778.209. Apportion the bonus across the weeks it covers, add it to the earnings for each of those weeks, recompute the regular rate, and pay the additional half-time premium on the overtime hours already worked.
Recalculating is arithmetic rather than judgment, and payroll systems handle it when they are told the bonus is nondiscretionary. Running it by hand is also realistic for a small team: the week-by-week top-up worksheet sits in the guide to discretionary and nondiscretionary bonuses, and the figure it produces goes into the overtime true-up column of the cost worksheet above.
What makes it dangerous is silence. An employer who pays a quarterly production bonus to hourly staff, never recalculates, and does this for three years has accumulated a back-pay exposure across everybody who worked overtime in that period. Nobody notices until somebody does.
State Withholding
Federal withholding is only half the calculation. Many states apply their own flat supplemental rate to bonuses, others require the standard withholding tables, and a handful have no income tax at all.
The practical consequence lands on anybody with employees in more than one state. A single company-wide supplemental rate will be wrong for some people, and not even in one direction: it over-withholds for some and under-withholds for others. This is one of the specific reasons multi-state payroll is harder than it looks.
Local taxes add a third layer in some jurisdictions. Where you have people in cities with their own income taxes, confirm the supplemental treatment there too rather than assuming it follows the state rule.
The California Bonus Rate
California is the state I get asked about most, and it uses two flat supplemental rates rather than one. Bonuses and stock options are withheld at 10.23 percent for state income tax, while other supplemental payments such as commissions and separately paid overtime are withheld at 6.6 percent.
Both figures come from the California Employment Development Department, and both sit on top of the federal rate rather than replacing it. Unlike the federal rule, which looks at whether the bonus is stated separately, California's turns on timing: a bonus paid at the same time as regular wages is calculated on the combined total for that payroll period.
Grossing Up
Grossing up means calculating backwards from the net to the gross, so the withholding comes out of a larger figure and the employee ends up with the intended amount. It is the tool for bonuses where the whole point is that somebody receives a specific round number.
Before approving a gross-up, look at the size of the multiplier. Approvals are frequently given against the net figure, and a $1,000 net payment costs considerably more than $1,000 to deliver.
Can a Bonus Be Paid Tax Free?
No. A cash bonus is wages, and no way of packaging it changes that. The idea usually arrives as a gift card, and that is the version worth settling before anybody buys one: cash and cash equivalents, gift cards included, are taxable wages no matter how small the amount, per IRS Publication 15-B (2026).
The rule people have in mind is the de minimis fringe benefit, which covers small non-cash items where accounting for the value would be impractical. A gift card fails that test because it functions as cash. A $50 card belongs on the payroll run with tax withheld, not on the expense account as a supplies purchase.
What genuinely lowers the tax on a bonus is deferral, and that is the employee's call rather than yours. Where the retirement plan allows a separate bonus deferral election, an employee can route part of the payment into their 401(k) as a pre-tax deferral.
The deferred portion stays out of wages subject to federal income tax for the year, though Social Security and Medicare still apply to it. Whether bonuses are eligible for deferral at all is a plan document question rather than a payroll setting, so confirm it before offering the choice.
When somebody asks how to avoid the tax on a bonus check, they are usually asking about the withholding rather than about tax planning. What that person needs is the one-sentence explanation of the flat rate, not a deferral election.
Timing and Year End
December bonuses are a habit rather than a rule, and the timing has consequences on both sides worth a moment's thought.
For the employee, the payment falls into the tax year they receive it, which matters at the edge of a bracket and rarely elsewhere. Deferring a payment to shift somebody's tax year is possible in principle, but constructive receipt (the rule that money made available can count as received) makes it a conversation with an accountant rather than a scheduling decision.
For the employer, January restarts the unemployment tax wage bases, so the same bonus frequently costs more in January than in December. Federal unemployment tax runs on the first $7,000 of each employee's wages in a calendar year (IRS Topic 759), and the state base sits alongside it.
Deductibility timing also depends on your accounting method and, for accrual taxpayers, on when the obligation became fixed. None of that should override the business reason for the timing, and all of it is worth knowing before the date gets set by tradition.
Where Small Employers Get This Wrong
Five patterns, and the first one is the only one that becomes a legal liability.
Not recalculating overtime after a nondiscretionary bonus is first, largest, and almost universal at small companies. It accumulates quietly across every overtime hour in every bonus period.
Calling a bonus discretionary because you decided the amount is second. Discretion over the amount is not the test; whether it was promised or formula-driven is.
Blending the bonus into a regular paycheck, with no separate amount shown, is third. It removes the flat rate option, forces aggregate withholding, and usually reduces the net the employee receives.
Not explaining the withholding rate beforehand is fourth. It is a one-sentence prevention for the entire category of complaint that follows every bonus run.
And budgeting the bonus without the employer taxes is last. A bonus pool approved at its gross figure is short by the payroll tax stack before anybody has considered the overtime true-up, and that gap is found at the worst possible moment, which is after the announcement.
Frequently Asked Questions
How are bonuses taxed?
A bonus is taxed as regular income at the same rates as salary; no special bonus tax exists. The difference lies in how much is withheld on payday. Federal rules classify a bonus as supplemental wages and let the employer pick one of two withholding methods. The percentage method takes a flat 22 percent on supplemental pay up to $1 million in a calendar year and 37 percent on anything beyond that. The aggregate method adds the bonus to the latest regular paycheck and works out withholding on the combined figure. Social Security and Medicare come out as they would from any paycheck, and the employee’s annual return settles the real tax whichever method was used.
Why was 22 percent withheld from my employee’s bonus?
Because you or your payroll provider used the percentage method for supplemental wages, which applies a flat 22 percent federal withholding rate to bonuses up to $1 million. It is a withholding rate rather than a tax rate. An employee whose marginal rate is 12 percent has had too much withheld and will get it back at filing; one whose marginal rate is 32 percent has had too little withheld and may owe. Saying this in one sentence before payday prevents most of the questions that otherwise follow.
Which withholding method should an employer use?
The percentage method is the better choice for most small businesses. One flat rate is easy to run, easy to predict, and easy for an employee to verify with a calculator. The aggregate method tends to withhold more, because adding the bonus to a regular paycheck makes that pay period look like a high-income one, so the employee takes home less and asks more questions. Whichever you pick, the employee’s tax for the year comes out the same. Two conditions apply to the flat rate: the bonus amount has to be shown separately, as its own payment or its own line, and federal income tax must have been withheld from the employee’s regular wages this year or last.
Do bonuses have Social Security and Medicare taken out?
Yes. Because a bonus counts as wages, Social Security and Medicare apply exactly as they do to regular pay, at 6.2 percent and 1.45 percent each for employee and employer, with Social Security limited by the annual wage base and Medicare uncapped. The additional Medicare tax applies to the employee above the relevant threshold. Federal and state unemployment taxes also apply where the employee has not yet reached those wage bases, which is why a bonus paid early in the year costs an employer more than the same bonus paid in December.
Does a bonus affect overtime pay?
A nondiscretionary bonus does, and it is the most expensive part of the whole subject. If the bonus was promised or announced ahead of time, or it follows a formula such as production, attendance, or hitting a target, it counts toward a non-exempt employee’s regular rate for the weeks it covers. The employer then has to spread the bonus across those weeks, work out the higher regular rate, and pay the extra half-time premium on overtime hours already worked. A bonus that is truly discretionary, meaning the employer chose to pay it afterward with no earlier promise and no formula, stays out of the regular rate.
How much does a bonus actually cost the employer?
More than the bonus itself. The employer pays its own 7.65 percent share of Social Security and Medicare on top of the gross amount, with the Social Security part capped once the employee passes the annual wage base. Federal and state unemployment taxes come on top for anyone still under those wage bases for the year. And if the bonus is nondiscretionary and non-exempt staff worked overtime in the period it covers, the overtime true-up is a further cost. Before unemployment taxes and any true-up, a $5,000 bonus comes to roughly $5,383 in total.
What does grossing up a bonus mean?
Grossing up means paying a larger gross bonus so the employee receives a specific net amount after withholding. If you want somebody to receive $1,000 in hand, you calculate backwards from the applicable withholding rates and pay a gross figure high enough that the net lands on the target. It costs meaningfully more than the headline number, and it works cleanly only where the withholding rate is predictable, which is another argument for the flat percentage method. Employers usually use it for recognition awards where an odd net figure would undercut the gesture.
Is it better to pay a bonus in December or January?
From the employer’s side, December is often the cheaper month, though the business reason for the timing should come first. For the employee, the pay date decides which tax year the bonus lands in, which mostly matters for someone near the edge of a bracket. For the employer, unemployment tax wage bases reset each January, so an early-year bonus often carries employer tax that the same payment in December would not, because by then many employees have already passed those bases. When the deduction lands also depends on your accounting method.