The holiday season is full of things to love—time with family, finding that perfect gift, and indulging in way too many treats. But the holidays can also be stressful. Between endless shopping, gaining winter weight, and awkward family conversations, it’s easy to feel overwhelmed.
A holiday bonus can help lighten the load, but for small businesses, budgets are tight. But you don’t need to break the bank to make a difference.
By giving bonuses the right way, you can help your employees keep more of their hard-earned money—and make their holidays a little brighter.
As a small business owner, you might want to spread holiday cheer by offering your employees a bonus. But how do you make sure your generosity actually helps?
Let’s see how you can give holiday bonuses in a way that helps your team keep more of their hard-earned money.
What is a Holiday Bonus?
A bonus is any extra money an employer gives employees in addition to their regular wages.
Bonuses are often used to reward employees for going above and beyond or to incentivize great performance. Sometimes they’re part of a compensation plan, but they can also just be given at the employer’s discretion.
For this article, we’re focusing on bonuses paid as checks. These are a fantastic way to reward your team—but the way you process the bonus can make a big difference in how much your employees actually take home.
Curious about how bonuses differ from commissions in payroll? Learn more here.
How Taxes Impact Holiday Bonuses
When it comes to keeping as much of the bonus as possible, the main obstacle is taxes—specifically federal withholding.
Federal taxes are often the largest chunk withheld, and while state withholding might also apply (we see you, California), we’re sticking with federal rules for simplicity.
3 Ways to Calculate Federal Withholding on Bonuses
Here’s the good news: there are three legal ways to calculate federal withholding on a bonus, and some are more favorable than others.
1. Using the Frequency of the Regular Paycheck
You may be wondering why frequency matters at all. Without getting too far in the weeds, frequency is important because how often you get paid has a big impact on your annual income.
This method treats the bonus as if it’s part of a regular paycheck. It’s simple, but it often leads to the highest withholding because the IRS assumes the higher paycheck is your employee’s ongoing earnings.
2. Flat 22% Withholding Rate
The IRS allows employers to withhold a flat 22% for bonuses. This is straightforward and can result in better take-home pay than the first method, but it’s not always the best option.
3. Using the Frequency of the Bonus Check (Best Option)
This method calculates withholding based on the bonus as a stand-alone payment with its own annualized schedule. By separating the bonus from regular wages, you can reduce withholding and help your employees take home more of their bonus.
Let’s look at an example to see how these methods play out.
Calculating Bonus Withholding
Meet Tony Test. Tony earns $48,000 a year and is paid biweekly, 26 times a year. His regular gross paycheck is $1,846.15, and he typically takes home $1,504.15 after taxes.
Now, let’s add a $1,000 year-end bonus to Tony’s paycheck:
Regular Paycheck Frequency:
By adding the bonus to Tony’s regular paycheck, the IRS assumes he earns $2,846.15 regularly. This results in higher withholding, leaving Tony with only $703.64 from his $1,000 bonus.
While it’s still a nice bonus, there is a simple way that employers can allow their employees to keep much more.
Bonus Check Frequency:
When the bonus is processed as a separate check, the withholding is calculated based on the bonus alone. Tony takes home $923.50—a $219.86 increase with no extra cost to you. That amount of money can have a huge impact on employee satisfaction, especially during the holiday season.
This method is simple but highly effective for maximizing employee satisfaction.
What About the Gross-Up Option?
Want to go the extra mile? The gross-up option ensures your employees receive the exact bonus amount you want them to keep, after taxes.
For example, if you want Tony to take home a full $1,000, you can calculate the gross amount needed to cover the taxes so his net payment hits $1,000.
While this method is more costly for you as the employer, it’s a great way to show your team how much you value them.
Make Your Employees Feel Valued
Bonuses are a great gift to give your employees, and there are ways to make your gift stretch further if you are intentional about it. Every cent counts during the holiday season, and doing things to make sure your employees can keep even just a little more could help their holiday spirit soar.
Embrace the Season of Giving!
Looking for other ways to make your employees feel valued and cared for through your business? Check out our blog, What Health Benefits Should I Offer My Employees?
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