IRS Announces New Withholding Rate on Bonuses Paid to Employees – Action Steps Required To Avoid IRS Underwithholding Penalty
The Good News
A company bonus paid to an employee is great news – it means more money in your wallet.
The Bad News
As with any form of compensation an employer pays to an employee, income tax withholdings (federal, state and local) are required. The amount of federal tax withholdings is dependent upon whether the employer includes the bonus in the employee’s regular paycheck or in a separately issued bonus check.
If the employer issues a separate bonus check, the IRS requires that such supplemental payments have a federal tax withholding rate of 22% (IR-2019-88). If the bonus is included with your normal paycheck, then your Form W-4 withholding allowances controls the taxes withheld.
Day of Reckoning
When the current year tax return is filed (usually by April 15 of the following year), if those bonus withholdings resulted in you overpaying your taxes, then you will recover those overpaid taxes when you file Form 1040. You may find this undesirable because you have given the IRS an interest-free loan.
If your bonus withholdings were too low, then you will not only owe the IRS a payment come April 15, but you may also have to pay a penalty for failure to pay sufficient taxes during the year.
Tax Planning Tip #1:
After the bonus is paid, provide your tax professional with your year-to-date pay stub and ask that s/he provide you with a projection of your current year taxes. If the finding is that you will be significantly overpaid, then a revised W-4 can be submitted to your employer to have fewer taxes withheld over the remainder of the year to get you closer to a break-even position. If you are significantly underpaid, again a revised W-4 can be submitted to your employer.
Some taxpayers do not realize that bonuses can create an underpayment situation for them. Assume that your effective tax rate is 37%. If the bonus payment is withheld at 22%, you can readily see that an underpayment situation may develop.
Tax Planning Tip #2:
If there is a significant balance due, you have two options. You can provide your employer with a revised W-4 to increase your withholdings during the remainder of the tax year to get you closer to a break-even position. You can also remit an estimated tax payment (Form 1040-ES) to the IRS to pay the shortfall.
We prefer the former because W-2 tax withholdings are considered ratably made throughout the calendar year, whereas an estimated tax payment is credited to your account on the date paid. For example, assume you receive a bonus payment in January but that you don’t meet with your tax advisor until May and then remit the estimated payment. Since the estimated tax payment was not made on or before April 15 (the first due date for making an estimated tax payment), you may have underpaid your taxes in the first quarter and be subject to an underpayment penalty.
Tax Planning Tip #3:
Change your mindset about paying income taxes. Rather than being reactive and wondering how to reduce your taxes in the waning days of the tax year, be proactive and consult with your tax advisor during the year to discuss life-changing events and changes to your financial situation.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.