Tax Implications of Year-End Bonuses and Raises Hudson Resident Looks Ahead to His Company’s Bonus

As the year winds down, many employees look forward to well-deserved bonuses or long-awaited pay raises. While these rewards recognize your hard work, they can also come with some unexpected tax consequences. Before you start spending that extra income, it’s worth understanding how bonuses and salary increases are taxed, and what you can do to keep more of your money in your pocket.

A Hudson, NH resident was anticipating a large bonus from his employer at the end of the year. Before planning what to do with the money, he wisely checked in with Merrimack Tax Associates to get a better understanding of the tax implications.

Understanding How Bonuses Are Taxed

Bonuses are considered supplemental income by the IRS. That means they’re taxed differently than your regular wages. Most employers use one of two methods to calculate taxes on bonuses:

The Percentage Method:

Under this method, your employer withholds a flat 22% federal tax rate on your bonus. This rate applies no matter how large or small the bonus is. Keep in mind that this is just for federal income tax, you will still owe Social Security, Medicare, and state income taxes where applicable.

The Aggregate Method:

In this approach, your employer adds your bonus to your most recent paycheck and withholds taxes as if it were one large payment. This can push your income into a higher bracket temporarily, leading to a higher withholding amount. However, if your overall income for the year doesn’t land in that higher bracket, you may get some of that money back when you file your return.

Other Tax Factors to Consider

Bonuses and raises can have a ripple effect on other parts of your tax situation. Here are a few things to keep in mind:

Retirement Contributions:

A higher income might make you eligible to contribute more to your 401(k) or IRA. Contributing extra before the year ends can help lower your taxable income.

Tax Credits and Deductions:

Some tax credits, like the Child Tax Credit or Earned Income Tax Credit, phase out as your

income increases. If a raise or bonus pushes you above those thresholds, your eligibility could decrease.

Withholding Adjustments:

If you expect to receive a large bonus or have multiple income sources, adjusting your withholdings now can prevent underpayment penalties later.

A year-end bonus or raise is always a reason to celebrate, but it’s also an opportunity to plan wisely. Understanding how these extra earnings are taxed helps you make informed decisions about spending, saving, and withholding. By reviewing your tax situation now, you can turn that reward into a long-term financial advantage.

The Hudson resident now has a better understanding of how his end of year bonus will be taxed, ensuring that there won’t be any surprises when it is time to file his taxes.