How an Employee Bonus is Taxed

Employee BonusAre you thinking of giving an employee bonus, holiday bonus, or year-end bonus? What’s the best way to handle these employee bonuses? Can they be handled ‘under the table’? Do you have to include them as wages on their W-2?

The answer to this question is quite simple. Any additional compensation to your employees over and above their standard salary or hourly rates is considered to be taxable compensation. The bonus is considered wages and must be reported as payroll on the employee’s W-2 and is subject to all applicable payroll taxes – federal and state withholding, FICA, Medicare and the related employer taxes.

On your books and records, the bonus is reported as wages on the income statement and it is fully deductible as a valid tax deduction if it is handled this way.  Payments to your employees made in cash (and not reported) or recorded as other expenses are not tax deductible, and may cause unforeseen issues if the IRS or state audits your books.

Many employers like to give a flat dollar bonus amount. You can do this by choosing the amount of the bonus you want hand to your employee and “gross-up” the amount. Most payroll services and payroll software can handle this calculation. By grossing up the flat dollar net amount, you are including the estimated taxes into the amount so that, after taxes, the amount is what you want to provide your employee.

The only way you can exclude the bonus payment from the employees’ W-2, not pay associated employer payroll taxes, and still get a tax deduction on your business tax return, is to make the bonus as a profit sharing bonus through your 401(k) profit sharing plan. Although your employees don’t get the bonus in cash or check, the bonus is completely non-taxable to the employee until they withdraw the funds from their plan, and you avoid paying the payroll taxes associated with paying the bonus in cash or check and including it on their W-2.


Adjusted Gross Income (AGI)

This may be the most important tax term since the tax code uses the Adjusted Gross Income (AGI) to limit a vast number of tax benefits. AGI is basically a taxpayer’s gross taxable income from all sources (gross income) reduced by certain allowable adjustments, sometimes referred to as above-the-line deductions, which are deductible whether or not the taxpayer itemizes their deductions. The more frequently encountered adjustments include deductions for deductible IRA contributions, moving, alimony payments, higher education interest, forfeited interest and deductions for health insurance premiums, pension plan contributions and 50% of SE tax for self-employed individuals.


Watch out for Corporate Records Services scam

A client of mine asked me about completing a form and paying $125.00 to a company called Corporate Records Services. They sent him a very official looking letter asking for corporate information and a check for $125.00. For a sample of the letter, click here.

I just happened across a warning about this yesterday from one of my LinkedIn attorney contacts. He had this posted on his LinkedIn profile:

“Right now business corporation owners all over the area (possibly entire state) are receiving official looking green envelopes from “Corporate Records Service” calling for “Annual Minutes Requirement Statement”. Be warned — this is NOT an official government mailing, this is NOT the Illinois Secretary of State, and you are NOT required to send this private company your corporate information and credit card information. I could not find “Corporate Records Service” company registered in the IL SOS database or authorized to do business here. Consult your legal adviser before doing anything.”

So be warned!

By the way, we are publishing this only as a warning to others. Please don’t call our office requesting confirmation of whether the letter you received is correct. We are a very busy CPA firm and we have been fielding many calls about this. If you have a question, we advise you to contact your own CPA or attorney.


Fake Affordable Care Act Websites Target Consumers for Identity Theft

Computer hackers are creating phony Affordable Care Act (ACA) websites and are asking for consumers’ personal information, such as social security and bank account numbers. The Better Business Bureau (BBB) warns consumers to never give out personal information on the Internet before confirming that the website is run by the government.
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