Year-end processing poses a number of challenges to payroll administrators, accountants, business owners, and employers of all types. Checkpoint Payroll has put together this series of articles aimed at guiding you through the trials of the year-end processing season.
As the holidays approach, many employers plan on paying out bonuses, incentives, or other supplemental wages to employees that may have unexpected tax and compliance implications. Payroll Guide ¶ 4100 et seq. contains a detailed discussion on supplemental wage payments.
Paying out bonuses
Employers have several options when it comes to paying out bonuses. You may choose to pay employees their additional wages on the same transaction as regular wages for a scheduled pay date, or you may choose to issue a separate payment on a different date. Whichever option you choose will have different tax and compliance implications. The Quick Reference Chart found at Payroll Guide ¶ 5021 is a great at-a-glance guide for state supplemental wage withholding compliance requirements.
When:
- For payments issued with a scheduled pay date, keep in mind that withholding calculated automatically in third-party software systems will often be much higher than expected, as the IRS withholding tables are used to match the frequency of the payment. Entering bonus wages on the same check as regular wages for a scheduled pay date will allow you to enter the bonus wages as an additional line item on the same check as the employee’s regular wages. With this option, the bonus wages will be combined with the regular wages for your standard pay period and the combined net will be issued to the employee on the standard pay date via the employee’s standard method of deposit. If you want a different amount of withholding, first ensure you are compliant with state and federal requirements for supplemental withholding based on the amount of additional pay you are issuing. The Checkpoint Payroll Chart for Supplemental Wages Paid with Regular Wages is an easy-to-use resource to double-check compliance before cutting bonus checks with your regularly scheduled payroll.
- For payments issued on a one-time basis separate from a regularly scheduled payroll, several states have requirements for withholding rates. To see if your state requires a specific withholding rate for separate payments, view the Checkpoint Payroll Chart for Supplemental Wages Not Paid at Same Time as Regular Wages to ensure compliance before cutting bonus checks outside of your regularly scheduled payroll.
- For payments issued after year-end, income will be recorded as paid in the following year, so income tax withholding, Social Security tax, Medicare tax, retirement contributions, and other benefit limits will reset. Keep this timing consideration in mind if your employees would benefit from a higher net amount or don’t want to deduct certain items from their bonus checks.
How:
- You may want to provide your employees with a specific amount, for example, a flat $100 bonus to take home. In order to do this, you will need to “gross up” the check to add the taxes owed back onto the amount you wish to pay. This will result in higher taxable wages for your employee on his or her W-2 at the end of the year and a higher amount withdrawn from your payroll account. For help in estimating what the total impact on your payroll account will be, Checkpoint Payroll offers a free Gross Up Calculator under Charts & Tools, then Payroll Calculators.
- If you would instead like to pay out a specific gross amount (the amount before taxes and deductions) and want to see what the potential net pay will be, Checkpoint Payroll offers a free Net Pay Calculator under Charts & Tools, then Payroll Calculators.
Special considerations:
- Deposit requirements. The IRS requires all deposits for Social Security, Medicare, and income tax withholding to be made within a certain amount of time after the payroll check date. Even if you are only issuing an annual bonus, you must make sure to comply with the deposit frequency established for you by the IRS. If you are unsure of your deposit frequency, see Payroll Guide ¶ 4285 for a detailed discussion on deposit frequency. Additionally, the IRS requires a next-day deposit if the total amount of Social Security, Medicare, and income tax withholding from the payroll will exceed $100,000. Several states match this federal requirement. The Checkpoint Payroll Chart for Deposit Frequency – 1 Day Deposit Rule is an easy-to-use resource to check state adherence to this rule.
- Large bonuses. In special cases, the IRS has additional requirements for larger bonus payout amounts. Specifically, when making an additional payment to an employee of $1 million or more, employers must withhold at the highest marginal income tax rate of 37%. This requirement is cumulative for all supplemental wage payments, so if an employee receives multiple bonuses in the year that combine to equal more than $1 million, the total amount of withholding must equal 37% (see Payroll Guide ¶ 4102 for more information).
Bonuses and other incentives are a great way to give back to employees and thank them for a job well done throughout the year. Be sure to save this article as a quick reference guide on ensuring compliance and accuracy when issuing these supplemental payments.