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Why did my federal withholding spike (employee)?

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  • Why did my federal withholding spike (employee)?

    I'm an employed physician and recently had a large bonus payment go through and some quick napkin math caught my eye. My last normal paycheck had a total tax withholding of ~26% and specifically $1800 for federal withholding. My most recent paycheck is about 2.5x my normal gross and has a total tax withholding of ~37% including a jump to $7400 for federal withholding. Why the sudden spike? Are tax brackets calculated on a per paycheck basis and I have to wait for next year's tax filing to get a refund?

  • #2
    When an employer pays a bonus, they can instruct the payroll service to tax that bonus in 3 different ways.

    Option 1: Employer says nothing and tax is withheld as if it is a regular pay period (pay amount gets annualized, leading to a very high withholding percentage).

    Option 2: Employer specifies that it is a bonus and tax is withheld as if the pay for the year is based on your regular pay periods.

    Option 3: The employer requests that a specific percentage of the bonus is taken out as withholding.

    Given the high withholding that you saw, it is likely that your employer chose option 1 In the final analysis, the withholding amount does not determine the taxes owed, that gets rectified when you file your annual return. But how you feel when you get your bonus is greatly affected by the taxes withheld. You may want to mention this to your employer for the next time.

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    • #3
      You'll get any tax overpayments back when you finalize your 2022 taxes. If you really wanted, you could adjust the withholdings the rest of the year to withhold a bit less to make up for it (assuming you're withholding an appropriate amount currently).

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      • #4
        Originally posted by White.Beard.Doc View Post
        When an employer pays a bonus, they can instruct the payroll service to tax that bonus in 3 different ways.

        Option 1: Employer says nothing and tax is withheld as if it is a regular pay period (pay amount gets annualized, leading to a very high withholding percentage).

        Option 2: Employer specifies that it is a bonus and tax is withheld as if the pay for the year is based on your regular pay periods.

        Option 3: The employer requests that a specific percentage of the bonus is taken out as withholding.

        Given the high withholding that you saw, it is likely that your employer chose option 1 In the final analysis, the withholding amount does not determine the taxes owed, that gets rectified when you file your annual return. But how you feel when you get your bonus is greatly affected by the taxes withheld. You may want to mention this to your employer for the next time.
        Ok this makes sense. Thanks.

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        • #5
          Originally posted by White.Beard.Doc View Post
          When an employer pays a bonus, they can instruct the payroll service to tax that bonus in 3 different ways.

          Option 1: Employer says nothing and tax is withheld as if it is a regular pay period (pay amount gets annualized, leading to a very high withholding percentage).

          Option 2: Employer specifies that it is a bonus and tax is withheld as if the pay for the year is based on your regular pay periods.

          Option 3: The employer requests that a specific percentage of the bonus is taken out as withholding.

          Given the high withholding that you saw, it is likely that your employer chose option 1 In the final analysis, the withholding amount does not determine the taxes owed, that gets rectified when you file your annual return. But how you feel when you get your bonus is greatly affected by the taxes withheld. You may want to mention this to your employer for the next time.
          This is one of the best answers I've ever seen to any question on any forum. I didn't even know 2 and 3 were options. Wish employers would take # 2 more often but in my experience # 1 is what always happens.
          Helping those who wear the white coat get a fair shake on Wall Street since 2011

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          • #6

            The two methods the IRS allows for calculating withholding for bonuses and other forms of supplemental income are the percentage method and the aggregate method.
            1. The percentage method
            If you receive a bonus separately from your regular paycheck, your employer is likely using the percentage method to calculate how much tax to withhold on your bonus.
            • Your total bonuses for the year get taxed at a 22% flat rate if they're under $1 million.
            • If your total bonuses are higher than $1 million, the first $1 million gets taxed at 22%, and every dollar over that gets taxed at 37%. Your employer must use the percentage method if the bonus is over $1 million.
            How it works:
            Scenario 1
            Ryan receives a $2,000 bonus. That bonus gets taxed at 22%, resulting in $440 of the bonus being withheld for taxes.
            $2,000 x 0.22 = $440.
            Scenario 2
            Julia receives a $1.5 million bonus this year. The first $1 million gets taxed at 22% and the remaining $500,000 gets taxed at 37%, resulting in $405,000 withheld for taxes.
            $1,000,000 x 0.22 = $220,000
            $500,000 x 0.37 = $185,000
            $220,000 + $185,000 = $405,000
            Benefit: The benefit of this percentage method is that it's relatively easy for the employer, so you'll often see taxes withheld this way on bonuses.
            Drawback: The disadvantage of this method is that most people's effective tax rate is not 22%. If you're in a higher tax bracket, there's a chance that not enough of your bonus was withheld for taxes, which can lead to a surprise tax bill at the end of the year. On the other hand, if you're in a lower federal tax bracket, your bonus might get taxed at a higher rate than your regular income. That means more of your bonus will be withheld, but you might get a tax refund when you file.
            2. The aggregate method
            The aggregate method is the second way employers can calculate taxes withheld on a bonus. This often occurs when your employer lumps your bonus and regular wages into one paycheck.
            • Your bonus and your regular income/wages are combined into one paycheck.
            • Your payroll department will withhold taxes on the entire aggregated payment at the same rate. That withholding rate depends on your filing status and the information you provided on your W4.
            How it works:
            Michael’s filing status is single. His regular biweekly wages are $2,000. During this pay period, he also received a $550 bonus, which his employer lumped together with his regular income.
            $2,000 (regular wages) + $550 (bonus) = $2,550 total biweekly earnings.
            According to the IRS's wage bracket withholding table,
            Michael's $2,550 paycheck triggers a standard withholding of $284.
            Benefit: While it's not perfect, the aggregate method has a better chance of ensuring that you're withholding enough to cover your tax liability. Translation: There’s a smaller chance of a surprise tax bill because of your bonus.
            Drawback: It requires more work for the employer to calculate — and it's still possible to withhold too much, which could mean a bigger bite out of your paycheck than necessary. But, on the bright side, it gives you a better chance of having an accurate withholding for the year, or possibly a refund.
            Aggregate vs. percentage method
            The bottom line is that neither the aggregate nor the percentage method is an exact science. Regardless of the calculation method, keep an eye on your total withholding for the year if you get a bonus. If you have a sense for what your total income will be, you can tinker with your W-4 and adjust your withholding to get out ahead of things before tax time.

            Most run a separate bonus payroll run and use a fixed percentage. I would appreciate knowing what payroll system is capable of Option 2: Regular pay rates? Tax withholding is a dynamic field, not a stored value.
            Last edited by Tim; 04-20-2022, 04:50 PM.

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