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If you've achieved some level of success in your career (or those new U.S Army ads really swayed you), then you may have negotiated yourself some bonus money at the start of your new job, referred to as a "signing bonus." These bad boys can be excellent injections of cash to get you going and to reward the hard work you've put into your career, but they can also bite you in the ass at tax time. Let's talk about signing bonuses and the various ways in which you could get taxed on this newfound category of supplemental wages.
When you receive a signing bonus, it's important to understand how it will be taxed. Any kind of bonus check comes with it a bonus tax rate, as it is considered supplemental income, which means it's treated differently than your regular income. In this article, we'll cover everything you need to know about signing bonus taxes, including how they're taxed, the tax rates, and how to maximize your bonus.
How Are Signing Bonuses Taxed?
A signing bonus is considered taxable income by the IRS. This means that it's subject to federal income taxes, state taxes, and Social Security and Medicare taxes. The IRS defines a signing bonus as a payment made to a new employee for signing on with an employer. This payment is in addition to the employee's regular wages.
When you receive a signing bonus, your employer will withhold taxes from it just like they do from your regular paycheck. The amount of taxes withheld will depend on the withholding method your employer uses. There are two methods that employers can use to withhold taxes from a signing bonus: the flat percentage method and the aggregate method.
Flat Percentage Method
The flat percentage method is the most common method used by employers to withhold taxes from a signing bonus. With this method, your employer withholds a flat rate of 22% for federal income taxes if the bonus is under $1 million. Any dollar over that $1 million mark will be taxed at 37%, but this is probably the least of your problems if you're raking in bonuses of over $1 million.
This is in addition to the Social Security and Medicare taxes that are withheld at a rate of 7.65%. The amount of state taxes withheld will depend on the state you live in (shout out the people in Nevada, Florida, Tennessee, etc).
The downside of this method is that it may underestimate the actual tax burden you should be shouldering, resulting in a potentially nasty tax bill come the following April.
Aggregate Method
The aggregate method is less common than the flat percentage method as it takes more work on the part of your employer, but it is usually more accurate. With this method, your employer adds your signing bonus to your regular wages and withholds taxes based on your normal rate. This method can be used when your signing bonus is paid out over multiple pay periods, but can also be applied to a lump-sum payment.
The downside of this one is that potentially too much will be taken out of your check, but it has the inverse of the Flat Percentage Method come tax time.
What Are the Tax Rates for Signing Bonuses?
Since signing bonuses are usually a one-time payment, they can put you in a higher tax bracket, which means you may owe more in taxes than you would with your regular paycheck.
Federal Income Taxes
The federal income tax rate for signing bonuses is the same as for your regular income. The tax brackets for 2023 range from 10% to 37%, depending on your income level and filing status (single vs jointly vs head of household). If you're in a higher tax bracket or your filing status is less tax advantageou, your signing bonus will be taxed at a higher rate.
State Income Taxes
The state income tax rate for signing bonuses varies by state. Some states don't have an income tax, while others have a flat rate or a progressive tax system. If you live in a state with a state income tax, you'll need to check the tax rate for your state.
Social Security and Medicare Taxes
Social Security and Medicare taxes are also known as FICA taxes. The FICA tax rate for 2023 is 7.65%. This rate is split between the employee and the employer. The employee pays 6.2% for Social Security taxes and 1.45% for Medicare taxes.
How to Maximize Your Signing Bonus
Here are some tips to help you maximize your signing bonus as a part of your overall tax burden:
Negotiate a Higher Bonus
If you're in high demand or have unique skills, you may be able to negotiate a higher signing bonus. Employers are often willing to pay more for top talent (especially in the 2023 labor market), so don't be afraid to ask for more to help offset the tax implication of your bonus (but this is a weird hamster wheel in which you'll likely never be satisfied).
Contribute to Retirement Accounts
Contributing to a tax-deferred retirement account like a 401(k) or traditional IRA can help reduce your taxable income and lower your tax liability. If your employer offers a 401(k) plan, consider contributing to it to reduce your overall taxable income.
Consider Health Savings Accounts
If your employer offers a health savings account (HSA), consider contributing to it with your signing bonus. HSAs are tax-deductible, which can help reduce your taxable income and lower your tax liability.
Take Advantage of Tax Deductions
There are several tax deductions you can take advantage of to reduce your taxable income. Some common tax deductions include the standard deduction, charitable contributions, and mortgage interest, but chat with your tax professional as some of these can have the opposite effect.
Seek Professional Tax Advice
If you're unsure about how to handle your signing bonus taxes, it's a good idea to seek professional tax advice. A tax professional can help you understand your tax liability and identify ways to reduce your tax bill.
The Good News About Signing Bonus Taxes
While signing bonus taxes can be complex, there's some good news. Unlike severance pay or year-end bonuses, which are typically paid out in a lump sum, signing bonuses are often paid out in a separate check. This means that you can see the amount of taxes withheld upfront and plan accordingly.
Additionally, if you overpay on your signing bonus taxes, you may be eligible for a tax refund when you file your tax return. This can help offset the higher tax rate you may have paid on your signing bonus, but there is literally no reason to do this. Voluntarily overpaying your taxes is giving the government an interest-free loan, which is not the behaviour of someone seeking immense wealth like yourself.
Conclusion
In summary, signing bonuses are considered supplemental income and are subject to federal income taxes, state taxes, and Social Security and Medicare taxes. Employers can withhold taxes from signing bonuses using the flat percentage method or the aggregate method. While signing bonus taxes can be complex, there are several ways to maximize your bonus, including negotiating for a higher bonus, contributing to retirement accounts, taking advantage of tax deductions, and seeking professional tax advice. With some planning and preparation, you can make the most of your signing bonus and minimize your tax liability.
