Nothing ruins the feeling of receiving a bonus at work than knowing you have to pay taxes on it.
Although bonuses are taxed any other type of income, there are a few things you can do to make sure you keep as much as possible. SmartAsset.com breaks down what you need to know about lowering your taxes on your next bonus, but first, you should understand that these strategies work by either reducing your gross income or increasing your deductions.
Contribute To Your Retirement Account
Tax-deferred retirement accounts are one of the easiest ways to avoid income taxes on your work bonus. Since contributing to a retirement vehicle such as a 401(k) or IRA lowers your gross income, it also reduces your tax burden.
The restrictions for various accounts change yearly. For 2020, you can contribute up to $19,500 to your 401(k), or between $6,000 and $7,000 to your IRA, depending on your age. Keep in mind that contributions to Roth IRAs are not tax-deductible.
Contribute To A Health Savings Account
Does your current health insurance policy have a high deductible? If so, you could qualify for health savings account (HSA) contributions. The amount that you contribute to an HSA is equal to how much you reduce your total income.
With an HSA, you can also withdraw funds to cover eligible medical costs without paying taxes, making this one of the best ways to avoid paying taxes on your bonus. Like 401(k)s and IRAs, you can only contribute so much to an HSA each year. This year, the limit is $3,500 for individuals and $7,000 for families.
These strategies might be well and good, but what if you’ve already reached your contribution limit? Or, what if receiving the bonus this year puts you in a higher tax bracket? In that case, you might consider asking your employer to wait until January to give you the bonus.
Whether you receive it now or in January, you will eventually have to pay taxes on this bonus. However, deferring compensation at least lets you postpone that tax bill for another year.
Make A Charitable Contribution
Do you itemize your deductions? If so, donating to charity is one way to lower your income — and your taxes. You could double up on and make one large donation for this year and next year, or contribute up to half of your adjusted gross income to an eligible charity.
Pay Medical Expenses
Do you itemize your deductions and also have a few medical expenses your insurance company didn’t cover? Then you may consider using your bonus to cover them. However, keep in mind that unreimbursed costs like these must make up 10% of your adjusted gross income to write them off your taxes.
Ask For A Non-Financial Bonus
You can’t pay taxes on a bonus if you don’t receive it at all. In this case, you could ask your boss to give you a non-financial bonus, like switching to remote work or a more flexible schedule.
If your employer agrees, make sure the non-financial bonus is genuinely tax-exempt. Some things, such as additional paid vacation hours, can count as a financial bonus.
Supplemental Vs. Regular Pay
How your employer pays your bonus can significantly affect how much taxes you pay on it. If the bonus is included in your standard paycheck, it will be subject to regular income taxes. But if you receive it as a standalone check, it is taxed at 22%.
Typically, you pay fewer taxes on supplemental income. You could consider asking your employer to send the bonus as a separate check. Of course, everyone is different, and how well this strategy works depends on your financial circumstances.
Bonuses of any kind are taxed like the rest of your earnings. These methods could help you lower your taxes so you can keep as much of that money as possible. But, keep in mind that most of these require reducing your gross income or increasing your deductions, which may offset the benefit. Talk to your employer about your benefits and see if you can work something out in your favor.
- Hendricks, Mark. “How to Avoid Paying Taxes on a Bonus Check.” Yahoo! Finance, Yahoo!, 19 Nov. 2020, finance.yahoo.com/news/avoid-paying-taxes-bonus-check-142810777.html.