Holiday Bonuses 101

Maximize Return and Minimize Taxes

Holiday Bonuses 101
November 22, 2018

If you received a holiday bonus this year, congratulations! A 2017 survey by Accounting Principals found that 63% of the surveyed companies plan to give out a year-end monetary bonus or gift this year based on company, departmental, and/or employee performance.

Your first thoughts are probably about how you plan to spend your reward. The effect on your taxes probably does not even cross your mind. It should, because it can affect what you decide to do with any significant bonus and/or keep you from any nasty tax surprises.

Let's start by looking at how holiday bonuses are usually taxed, starting with a straightforward extra check.

Bonuses as Supplementary Income

The IRS generally considers bonuses to be supplemental income, and they are usually taxed that way within a separate bracket. They are considered discretionary rewards that constitute a surprise to the employee.

The discretionary definition still holds even if your employer gives the same holiday bonus every year – because the employer is not obligated to give the amount (compared to a contractual performance reward or pay for overtime work).

Bonuses usually appear on your W-2 form in a separate row labeled "supplementary income" with the appropriate withholdings shown. If not, your employer has probably chosen to classify the bonus as part of your regular wages, and it will be taxed at your nominal rate.

For most of us, the distinction does not matter much, but if you are dealing with a bonus large enough to bump you into a different tax bracket or disqualify you from deductions and/or tax credits, this point deserves extra attention.

Bonuses as Part of Wages

When the bonus is included in your wages, your employer may give you an opportunity to change your withholding for the single period that includes the bonus, allowing you to keep more of the money – or they may have incorporated extra into the amount to account for a withholding difference. Check with your HR or accounting department to see what options you may have.

Assuming you resist the urge to spend your bonus, how can you maximize its effect? The easiest way is to contribute it into your 401(k) if your employer allows this. If a portion of the reward was already diverted into the 401(k), see if you can increase the percentage – but make sure you are staying within your yearly contribution limit.

You may also be able to contribute your year-end check to other tax-beneficial accounts. Contributing to a Health Savings Account (HSA) or a Flexible Savings Account (FSA) may be able to reduce your taxable income and increase your health benefits (in the case of an FSA, make sure you will be able to spend it in sufficient time to avoid losing the benefit).

You can also consider an IRA, either traditional or Roth, as a way to maximize your holiday bonus. As with all of the above accounts, make sure you are staying within your contribution limits.

Non-cash Bonuses

What about smaller non-cash bonuses such as Thanksgiving turkeys and Christmas baskets? They are usually considered non-taxable fringe benefits (legally known as de minimis benefits). However, if the gift is in a form that can be converted to cash such as a store gift card, it will be considered a taxable benefit. If you are not sure, check with your HR or accounting department.

Enjoy that holiday bonus, and take a few minutes to plan the best way to use it. Try to maximize your tax and savings benefits – but feel free to use a responsible amount to splurge. A bonus should wind up making you feel good!

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Steffanie | 12.03.15 @ 18:01
We love bonuses and tend to do something special with the kids when we get them.
Britt | 12.03.15 @ 18:01
My husband's job gives him a $250 christmas bonus every year, which is always a nice little surprise.
trish | 12.03.15 @ 18:02
Haven't received one yet. But hopefully this year we will!
Erin | 12.03.15 @ 18:02
Bonuses are a nice perk if you can get them. They are not something that I would count on when planning out your yearly budget though.
Elaine | 12.03.15 @ 18:02
Of course it is taxable not really shocked. The government will always get theirs.
Kailie | 12.03.15 @ 18:02
This is the first job I have ever had that actually does bonuses, so it'll be a nice boost to my income this season'!
Carla | 12.03.15 @ 18:04
My husbands bonus comes in the form of a small ham and a couple packs of bacon. We are grateful for what we get.
Bobbie | 12.03.15 @ 18:10
I loved it when the boss gave bonuses like a huge fruit or nut basket or even a gift card to the grocery store. I was OK with checks and stuff, even though they always took taxes out. Always grateful no matter how large or small.
Amanda | 12.03.15 @ 18:10
We love the bonuses just wished it was tax free instead of taxes eating half of it. But still very grateful for the bonus as it always helps finish up those last minute gifts or we save it for vacation fund.
Jane | 12.03.15 @ 18:12
I've never been put into a higher tax bracket due to a bonus, but it definitely is something to consider.
Clarissa | 12.03.15 @ 18:14
My company doesn't offer bonuses for non corporate employees. But something neat they do is for 12 days they draw an employees name and that person will receive a visa gift card for $100. It's not much, but it's something. In lieu of bonuses, supervisors usually have a team party and pay for a catered meal.
Sara | 12.03.15 @ 19:01
Bonuses are always a nice surprise especially when unexpected
$commenter.renderDisplayableName() | 01.28.21 @ 01:03