Annual Bonus Check - Changing Witholding to "Exempt" a bad idea?

Question

Hey all,

I have a regular W2 job that provides a substantial bonus check annually. Over the years I have heard of gossip that changing my withholding for this single paycheck is the best tax strategy. My employer combines my regular paycheck and bonus paycheck in the same item.

Common sense would tell me that at the end of the day it wont effect taxes paid over the course of the year, and rather this is a "would you rather it pay it now, or pay it later" situation. The latter being in the form of a bigger return at year end, rather than owing money. That being said I understand bonuses are taxed higher, so maybe going exempt is a viable tax strategy for this one pay period?

Thanks

Account Closed · Answer

Your paycheck and your bonus is in the end taxed at the same rate. The only difference is what was said above, that at the time of the bonus payment it is taxed at (normally) a higher rate for whatever reason, reason doesn’t matter.

In the end you get your W2 and it is taxed all the same.

So if you exempt all you are doing is saying I’d like to take some of my tax return and have it paid to me right now.

Now a tax strategy would be planning to get ZERO dollars back at the end of the year, which means you paid exactly what you should of at the time of each of your paychecks. But it does no good if you don’t use that money for real estate or some other type of investment.

OR alternatively

Set your taxes to get a huge refund at the end of the year which is basically forcing you to save, but with ZERO interest for the year.

Either way you can blow thru that money. Only you know what works for you.

Mike M. · Answer

We get bonuses 1x/year aka annually. Going "exempt" on this bonus check will not impact how much tax i pay over the course of the year vs not going exempt? Are you saying its a preference rather if i want to pay my taxes now or pay my taxes later?

I thought bonuses were taxed at a higher %. In reviewing my W2 i don't see a part for bonus income.

Basit Siddiqi · Answer

@Mike M.Changing withholding is not considered a tax strategy. Maybe it can be considered so if you itemize and would benefit from the extra state withholding in one year.change in withholding, as you mentioned, will have an impact on what you pay or get back as a refund when you file your return. You don't want to underpay as you may have some penalties for doing so.A strategy I argue is something that will impact your taxable income/tax liability.Furthermore, bonus payments are not necessarily tax differently than other income you would receive from an employer. The income gets taxed at your marginal tax rate so if you make more money, you can get bumped into a higher tax bracket.

Steve Lovett · Answer

The best piece of advice I can give is to go seek direct tax advice from a tax professional. Your situation may be vastly different than your friends' situation and there is no one size fits all approach to tax advice. With respect to your question, the actual tax rate on the bonus depends on your company's preferred method of bonus withholding. They may opt for a flat 22% or group it with the rest of your wages and tax it as any other paycheck. There are other withholding options for your employer and it changes if you make over $1 million.

The key here, and why the answer is different for each and every person, is that the IRS requires withholding throughout the year to make sure that you are not subject to under-withholding penalties. For W-2 employees this is usually not an issue, but for self-employed business owners it may be a much bigger issue. So long story short, it is best to seek tax advice from someone who can see your whole tax picture and give you specific tax planning strategies for your situation. Hope this helps!

Annual Bonus Check - Changing Witholding to "Exempt" a bad idea?

4 Replies