There is so much to love about the holiday season! Spending time with your family, finding that perfect gift for someone special, eating so much you feel 20lbs heavier, etc. There are also a lot of reasons people struggle with the holiday season—endless hours of shopping, gaining winter weight, and having to muscle through the expectations and conversations with extended family.
It’s no longer a little-known fact that this time of year is stressful. That stress can turn the same things that we look forward to into things we dread. A sizable holiday bonus can help alleviate some of that stress, but many small businesses can hardly afford to give all their employees a check big enough to make that visit with the in-laws feel worthwhile. Not to fear—you can still make a difference! The best thing a small business owner CAN do is make sure that any bonus they do give out is given in a way that allows their employees to keep as much as possible.
What IS a holiday bonus?
In general, a bonus is any amount of money that an employer chooses to give to their employee in addition to their regular earned wages. Often, they are used to incentivize or reward employees for working above and beyond their typical job description. Sometimes they are baked into the compensation plan from the onset of the job offer, and other times they are given out entirely at the discretion of the employer. The more complicated part comes when it's time to give the employee the bonus. Curious how bonuses are different than commissions when it comes to payroll? Learn about that here.
We are looking specifically at bonuses that are paid out through a check to an employee. We cover the best way to ensure your employees keep the most they can and show a way you can go above and beyond for a team that went above and beyond for you.
How to calculate federal withholding of a holiday bonus
When we talk about keeping as much of the bonus as possible, what we are up against is the tax calculation, more specifically, the calculation of the federal withholding. Most of the time, the largest portion that gets withheld is the federal withholding. We aren’t going to talk about state withholding because each state is different, but sometimes state withholding could be sizable too. (Looking at you, California).
There are three ways to legally calculate federal withholding on a bonus. The first way is using the frequency of the regular paycheck. Second is 22% of the total bonus. Third, and the best way, use the frequency of the bonus check. Let’s break that down.
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. Someone who gets two $20,000 checks in a year should be taxed the same as someone who gets four $10,000 checks. Below you see an image of fake check information for my model employee, Tony Test. Tony earns $48,000 a year, and he is paid bi-weekly, 26 times a year.
Each paycheck, Tony nets $1,504.15 from his gross wages of $1,846.15.
So, let’s look at what happens when we enter a $1,000 year-end bonus for Tony, taxing the bonus at his regular pay frequency. Pay attention to the amount his net and Federal withholding increase.
Notice that we more than doubled the amount that is being withheld from Tony for Federal tax. That $1,000 bonus became $703.64. While it’s still a nice bonus, there is a simple way that employers can allow their employees to keep much more.
If you remember from before, the IRS thinks that Tony is going to gross his check amount 26 times a year. The calculation was made thinking that he was regularly earning $2,846.15. For a year-end bonus, we can make the calculation happen on an annual schedule. The federal withholding can be calculated more accurately, and your employee will be happier with the amount that they end up with.
As the image shows above, a correctly scheduled bonus check nets out to $923.50, a whopping $219.86 increase with no additional charge to the employer. That amount of money can have a huge impact on employee satisfaction, especially during the holiday season.
A final way to enter a paid bonus is to use a gross-up option. If an employer wants to make sure that their employee nets a specific amount from a bonus, they choose to use the gross-up option. This option calculates what the gross amount needs to be in order to end up at the desired net amount. Here is what it would look like if Tony’s employer wanted to write him a gross-up year end bonus for $1,000.
With this option, you will notice that the gross amount has increased, which in turn will increase the amount of employer taxes on this bonus. The gross-up option is more costly to the employer, but it’s an option to consider. It is surreal to see a check that rounds out to a net payment of a full $1,000. It’s like being transported into a movie where taxes can’t reach you. If you find yourself in a position that allows you to bless your employees with this dream-like experience, in the spirit of giving, you should consider paying the small amount extra to make it a reality.
Make your employees feel valued. Embrace the season of giving!
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.
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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