Expecting A Work Bonus? 3 Tax Planning Moves To Consider

Do you expect to receive a bonus or commission at work by the end of the year? If so, one important move you should make now is to do some tax planning for it. What planning moves now can help you later? Here are three things to consider. 

1. Plan for Withholding

Bonus checks may or may not see the same tax withholding rates as the rest of your compensation. Generally, this depends on how your employer reports and pays the bonus. If it's lumped in with your regular salary, the withholding will likely be done at the same rate. However, if it's paid separately or listed separately on checks, a special 22% withholding rate may apply.

First, learn how your employer plans to report the bonus. If you have any choice in the matter, you might ask for it to be reported in the way that will provide a better withholding outcome. If your normal tax rate, for example, is greater than 22%, you may not see enough withheld if it's reported separately. Conversely, this rate could be too high for someone with a lower effective income tax rate. 

2. Consider Making Contributions

Want to mitigate the tax impact of your year-end bonus? One of the best, and easiest, ways is to make a contribution to a tax-advantaged account.

Accounts such as a company 401(k), Health Savings Account, or traditional IRA allow you to contribute up to the maximum annual allowance without being taxed on that income this year. If you haven't reached that limit, do the math on how much your taxes will be lowered from such a contribution. 

Alternatively, consider the value of contributing some or all of a bonus to a Roth IRA or Roth 401(k) which provides tax-free growth and withdrawals later on. This is often a better choice if you have a low effective tax rate now and expect higher taxes in retirement. 

3. Check the Timing of the Bonus

Will your bonus be attributed to 2021 or 2022 income? If you can affect the timing of your payout, you may be able to reduce taxes during one or both years. 

Consider your income as a whole for each year. If you had a good year with lots of income, postponing a bonus until January could prevent you from being bumped up into a higher tax bracket in the current year. But if you have plenty of deductions or earned less overall, you may want to pay taxes on the bonus at 2021 rates. 

Where to Start

Want help determining how best to minimize taxes on your bonus check? Want information on tax-advantaged accounts, withholding rates, or tax brackets? Start by meeting with an experienced accountant in your state. With their help, you will ensure your bonus boosts your finances without any unwanted tax surprises.