Did you have a good year? Rewarding your staff for a job well done is a key to retaining good employees. Why not celebrate the work you and your employees accomplished! If you’re planning on giving your employees a bonus, or thinking about it, Cardinal has important Tax information that you need to know about end of the year employee bonuses and options for how to set them up in your payroll system.
IRS INFO ON TAXATION OF BONUSES/SUPPLEMENTAL INCOME
The IRS considers bonuses to be supplemental income, along with commissions, severance pay, awards and prizes, back pay and retro pay increases. When an employer wants to give an employee a bonus, the taxed amount is usually calculated by one of these formulas:
- A gross amount in which taxes are removed from the net.
- A specific net amount, where the gross is adjusted to allow for taxes.
As such, these payments may be subject to different taxation. Below are the IRS rules for these wages as well as Cardinal Services Inc.’s recommendations on how you set up your employee payroll deductions for their payment.
Issue #1 – Income Tax Withholding
Federal and state laws require supplemental wages to be taxed differently than regular wages, which are taxed based on the employee’s W4 withholding designation. The exception to this: If the supplemental income is included in the same check as the employee’s regular pay. In this case, the W4 designation would apply.
When a specific net amount bonus is paid, the result is a different GROSS pay amount would be needed for employees to receive a specific NET pay amount. Where you might only need to pay one employee $900 to achieve a $600 net, you might have to pay a different employee $1100 or $1200.
Issue #2 – Other Withholdings
Voluntary deductions, like 401k deferrals, often have to be applied to supplemental wages. The same is almost always true with involuntary deductions, like garnishments. These amounts would need to be deducted from the net pay, so employees who have these deductions would not receive the employer’s designated net amount.
Issue #3 – Separate Pay Check for the Supplemental Wage
If supplemental pay is not paid on the same check as regular pay, the IRS has determined that those wages be taxed at a flat 22%. Oregon and California have similar requirements, with flat rates of 9.0% and 10.23% for bonuses and 6.6% for other supplemental wages, respectively (other state rates may vary). The result is most employees will have their income taxes OVER-withheld.
Issue #4 – Client billed amount for wages that are marked up to bring the net to a certain amount
If the desire is to have the employee receive a set amount for the supplemental wages (in most cases, bonuses), the gross wages needs to be adjusted to allow for the different taxation. Since the amount a client is billed is based on the GROSS pay, the adjustment will most likely result in a higher billed amount to the client.
CARDINAL RECOMMENDS USING THIS PAYROLL BONUS PROCEDURE
With all of the above in mind, Cardinal recommends these options:
- Make bonuses gross, not net.
- Include the supplemental pay with the regular timecard. This minimizes extra-withholding of your employees’ pay.
- Submit the gross amount for the supplemental wages, then have the appropriate taxes and deductions applied to give a net check. This would be done instead of submitting a set net bonus amount and having the gross wages adjusted to account for the taxes.
- Options for processing the supplemental wages are :
- Supplemental wages are paid in the pay period for regular wages and included on the same check as regular wages – this would result in the W4 determining the taxes withheld.
- Pay the supplemental wages in a separate check (whether in or outside of the regular pay cycle) using the flat rate tax amounts of 22% for federal, 9% for Oregon state taxes and 10.23% or 6.6% for California state taxes depending on the type of supplemental income (other state rates may vary).
SELECT ONE OF THESE OPTIONS
And let Cardinal Services’ payroll department which option you would like to select:
- If you want this bonus included in your employees’ regular pay, and on the same check, please let Cardinal know when you submit the time and indicate the bonus.
- If you want the bonus in a separate check, Option 4b—the supplemental wage taxation will apply— please let Cardinal know when you submit the time and indicate the bonus.
Thank you for your continued business.
Please contact Cardinal if you have any questions or if we can help you in any way with your bonus plans.