How Are Bonuses Taxed: State Variations & Withdrawal Methods in the U.S.

How Are Bonuses Taxed?

Bonuses are additional payments employers provide to employees, often as rewards for performance or at specific times like year-end. In the United States, bonuses are classified as "supplemental wages" by the IRS, meaning they are taxed differently from a regular salary. Here’s a quick list of types of bonuses that qualify:

• Performance bonuses
• Sign-on bonuses
• Referral bonuses
• Holiday bonuses
• Commissions
• Awards and prizes

Bonuses are considered part of an employee's total taxable income when they file their annual tax returns – the tax is calculated using the same standard federal income tax brackets as regular wages. The difference lies in the withholding method used by employers when paying employees, which we’ll cover later in this guide. 

Regardless of the withholding method, bonuses are also subject to Social Security and Medicare taxes (FICA), which are withheld at a combined rate of 7.65% up to the Social Security wage base limit. Additionally, state and local taxes may apply, depending on the employee's location. At the end of the year, employees report their total income, including bonuses, on their tax return, and any over- or under-withheld taxes are reconciled accordingly. 

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Current Bonus Tax Rate in 2025

So, exactly how much are bonuses taxed? Here’s a breakdown of the federal rates, with a practical examples, when calculating payroll taxes:

Federal Tax Rates

Bonuses are taxed at the federal level as supplemental income, with a flat withholding rate of:

• 22% for bonuses up to $1 million
• 37% for amounts exceeding $1 million

On top of that, bonuses are subject to FICA taxes which include:

• Social Security Tax: 6.2% on the first $176,100 of total wages (employer and employee each pay 6.2%, totaling 12.4%).
• Medicare Tax: 1.45% on all wages (employer and employee each pay 1.45%, totaling 2.9%), with an additional 0.9% for wages over $200,000 (single filers) or $250,000 (joint filers), paid only by the employee.

Example of How Bonuses Are Taxed

For a $5,000 bonus in 2025, assuming the employee’s total wages are below the Social Security wage base:

• Federal Income Tax: $5,000 × 22% = $1,100
• Social Security: $5,000 × 6.2% = $310
• Medicare: $5,000 × 1.45% = $72.50
• Total Federal Taxes: $1,100 + $310 + $72.50 = $1,482.50
• Net Bonus (before any applicable state taxes): $5,000 - $1,482.50 = $3,517.50

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How Are Taxes Withheld on Bonus Payments?

Employers have two main options for withholding taxes on bonuses, each with its own pros and cons:

1. The Percentage Method

A flat federal rate of 22% applies to the bonus (37% for amounts over $1 million). This method is ideal for one-time or infrequent bonuses paid separately.

• Pros: Simple, predictable, and easy for smaller bonuses.
• Cons: Might not align with your employee’s actual tax bracket, potentially leading to over- or under-withholding.

2. The Aggregate Method

The bonus is added to the regular paycheck and taxed at the employee’s regular withholding rate based on their W-4. This method is suited for regular or larger bonuses.

• Pros: More accurate, reflects the employee’s tax bracket.
• Cons: More complex calculations, which varies with the bonus timing.

Example:
If an employee with a $3,000 paycheck gets a $10,000 bonus, the aggregate method adds the bonus to the paycheck for a total of $13,000. At a 25% tax rate, $3,250 would be withheld.

Note: For bonuses over $1 million, the percentage method is mandatory.
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How to Lower Taxes on Bonuses

If you’re in HR, you can help employees minimize the tax impact on bonuses in a few ways. Here are six strategies that can make a difference:

Adjust Your W-4 Form

Encourage employees to adjust their W-4 to alter their withholding allowances. By increasing the number of allowances, they can reduce the amount of tax withheld from their bonus. But make sure the total withholding aligns with the actual tax liability, since under-withholding could lead to penalties.

Contribute to Tax-Advantaged Accounts

Employees can boost their retirement savings by contributing to tax-advantaged accounts like a 401(k). In 2025, those under 50 can contribute up to $23,500, and those 50+ can contribute up to $31,000. This not only reduces their taxable income for the current year, but it also builds their future financial security.

Understand and Influence Withholding Methods

There are two main ways you can withhold taxes on bonuses as an employer: the percentage method and the aggregate method. The percentage method applies a flat 22% federal tax rate, while the aggregate method combines the bonus with regular wages and withholds based on the total income. 

Employees in lower tax brackets might prefer the percentage method, hoping for an overpayment they can later get back, while those in higher brackets might prefer the aggregate method to avoid a surprise tax bill.

Consult a Tax Professional

Tax professionals can offer personalized advice on deductions and credits, and help employees fine-tune their strategies to minimize their overall tax liability. Offer your team recommendations for experts you trust.

Time Your Bonuses for Tax Efficiency

Timing bonuses right can help employees reduce their tax burden. For example, deferring a bonus to January spreads the income across two years, potentially lowering the overall taxable amount. If the employee expects a lower income next year, this strategy could be a win.

Consider Alternatives to Cash Bonuses

Instead of a traditional cash bonus, consider offering non-cash perks like stock options or deferred compensation. Stock options are taxed at capital gains rates, which can be lower than regular income tax rates. Deferred compensation, on the other hand, allows employees to delay paying taxes on income until a later date – helping to reduce their taxable income in the current year. 

However, keep in mind that stock options come with market risks, and deferred compensation requires employees to wait before cashing out.
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State-Specific Tax Considerations 

State taxes on bonuses differ widely, and some states don’t have specific supplemental rates, instead taxing them like regular income. Here’s an overview of how various states handle bonus taxation in 2025:

For multi-state employers, taxes must be withheld based on the employee’s state of residence, not the company’s headquarters.

Example Calculation (State Taxes):

Let’s compare state taxes on bonuses in California and Texas:

In California, bonuses are subject to a flat state withholding rate of 10.23%. Additionally, federal withholding applies at 22%, and both Social Security and Medicare taxes are withheld at 6.2% and 1.45%, respectively.

• State Tax (10.23%): $5,000 × 10.23% = $511.50
• Federal Tax (22%): $5,000 × 22% = $1,100.00
• Social Security (6.2%): $5,000 × 6.2% = $310.00
• Medicare (1.45%): $5,000 × 1.45% = $72.50

Total Withholding = $1,994.00

Net Bonus: $5,000 - $1,994.00 = $3,006.00

Texas does not impose a state income tax, so the only withholdings on a bonus are federal taxes and FICA (Social Security and Medicare).

• Federal Tax (22%): $5,000 × 22% = $1,100.00
• Social Security (6.2%): $5,000 × 6.2% = $310.00
• Medicare (1.45%): $5,000 × 1.45% = $72.50

Total Withholding = $1,482.50

Net Bonus: $5,000 - $1,482.50 = $3,517.50
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Compliance Requirements for HR Managers

Here's what you need to know to stay compliant with federal and state tax laws, as an HR manager:

Reporting Bonuses on Form W-2

Bonuses are treated as supplemental wages and must be reported on Form W-2 as part of an employee’s taxable income. You have to provide Form W-2 to employees and also file it with the Social Security Administration (SSA) by January 31 each year. This should detail all wages and taxes withheld, including bonuses – to avoid penalties, don’t miss this deadline.

Penalties for Incorrect Withholding

If taxes aren't withheld correctly from employee bonuses, both employers and employees could face steep penalties. Employers are responsible for making sure the right amount of federal income tax, Social Security, and Medicare taxes are taken out. 

If the IRS finds that the withholding was wrong because of payroll errors or intentional disregard, employers might face penalties of up to 20% of the taxes that were underpaid. Employees may also be hit with underpayment penalties when they file their own tax returns.

Strategies for Multi-State Employers

For employers with workers in multiple states, it can be difficult to keep up with different state tax rates and agreements between states. Good global payroll software can help you track where your employees are located and simplify compliance requirements. These tools can automatically calculate taxes, ensure the company follows state rules, and help manage tax withholding more accurately. 

Stay updated on the tax laws and agreements in every state you’re operational, to proactively avoid compliance problems.

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Communicating with Employees on Why Tax Withholding on Bonuses May Be High

High withholding rates can come as a surprise to employees – clearly communicate the tax implications to help prevent any confusion. Here’s how to keep your team informed:

• Explain the Math: Use examples like those above to show how federal (22%) and state taxes reduce net bonuses.
• Provide Tools: Share free resources for employees to estimate take-home pay.
• Host Workshops: Offer training sessions on bonus taxation and W-4 adjustments.
• Encourage Tax Advice: Suggest consulting professionals for personalized strategies.

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Key Takeaways

If bonuses are a key part of your total rewards strategy, you’ll need to reckon with the taxes involved. To make sure every employee can receive a bonus without issues, familiarize yourself with the federal and relevant state tax rules, pick the right withholding method that best suits your employees – and keep open communication lines with your team.

Simplifying Bonus Tax Compliance with Playroll

Keeping track of varying federal and state tax regulations can be hard to juggle. Playroll helps automate payroll and bonus tax calculations, ensuring you stay compliant across all states and countries, no matter where your employees are located. We can help:

• Automatically calculate federal, state, and local taxes on bonuses
  
• Eliminate the guesswork by keeping you updated on the unique tax rates for each state
  
• Reduce compliance risk with built-in tools to handle multi-state employees effortlessly
• Simplify the process of providing competitive, global benefits to your team

Ready to simplify your payroll processes? Book a chat with our experts to see how we can help streamline your payroll operations and ensure your team gets their bonuses – taxes and all – handled seamlessly.