How to Issue a Bonus

Bonuses are employment income, they're taxable and subject to payroll withholdings, just like regular wages. The main difference is that lump-sum payments like bonuses are often withheld at a higher rate because the IRS treats them differently from a regular paycheck. This article covers how to issue a bonus correctly so the tax treatment is right and the employee isn't surprised.

What You'll Need

• Access to QBO Payroll (or your payroll software)
• The bonus amount
• The payment date

How Bonuses Are Taxed

When you pay a bonus, standard withholding rules still apply, but the IRS allows (and most payroll software uses) a flat supplemental wage withholding method:

• Federal income tax: 22% flat rate for supplemental wages under $1 million (2024). Alternatively, the software can use the aggregate method, which adds the bonus to regular wages and applies the marginal rate, results vary by employee income level.
• Social Security: 6.2%, applied to the bonus amount up to the annual wage base (applies as long as the employee hasn't yet hit $168,600 in wages for the year)
• Medicare: 1.45% on all bonus amounts
• California PIT: California uses its own supplemental wage rate (currently 10.23% for 2024)
• SDI: 1.1% (same as regular wages)

The 22% federal flat rate often results in more tax withheld than the employee expects, but it doesn't mean they'll owe more at year-end. It's a timing issue: over-withheld amounts come back as a refund when they file their personal return.

QBO Payroll handles supplemental wage calculations automatically.

Normal Procedure

Issuing a bonus as a separate payroll run

The cleanest approach is to process the bonus as an off-cycle payroll run:

1. In QBO Payroll, go to Run Payroll.
2. Select the employee(s) receiving the bonus.
3. Under pay type, select Bonus (or add it as a pay type if not already set up).
4. Enter the bonus amount.
5. QBO calculates all withholdings using the supplemental wage method.
6. Review the deductions and approve.
7. Process the payment on the desired date.

Including a bonus in a regular payroll run

You can also add a bonus to the employee's regular pay period:

1. Run payroll as normal.
2. In the bonus pay type field, enter the bonus amount alongside regular earnings.
3. Review the withholdings carefully, combining bonus and regular pay in one run can shift the total withholding calculation. Separate runs are cleaner.

Abnormal Procedures

The employee wants the bonus grossed up so they take home a specific net amount.

A gross-up means you increase the bonus so that after all withholdings, the employee takes home the amount you intended. If you want them to receive $5,000 net and the effective withholding rate is approximately 35%, the gross bonus needs to be higher. Your NCO bookkeeper can calculate the correct gross-up amount.

You want to defer the bonus to the next calendar year.

For a C-corporation, a bonus accrued in one fiscal year is only deductible in that year if it's paid within 2.5 months of the fiscal year-end (for accrual-basis taxpayers). If you're accruing a year-end bonus, confirm the deduction timing with your NCO advisor before deciding when to pay it.

You want to bonus a contractor rather than an employee.

Contractor bonuses are additional payments, no payroll processing required. Pay the additional amount, make sure it's included in the contractor's total for the year, and update the 1099-NEC if the total crosses (or now exceeds) $600. See: How to Prepare and File 1099s.

California minimum wage applies to the bonus period.

If you pay an employee a bonus and they also work hourly, California's overtime rules can be affected. A non-discretionary bonus (one the employee had a right to earn based on a formula) must be factored into the regular rate of pay for overtime calculations during the period it covers. This is a complex calculation, consult your NCO advisor if applicable.

FAQ

Why was the withholding on the bonus higher than the employee expected?

The flat supplemental rate (22% federal, 10.23% California) is applied to the bonus directly, rather than using the employee's regular withholding rate. The employee likely won't owe more total tax, they may get more back at year-end if they were over-withheld. It's a withholding timing issue, not a higher tax rate.

Can I pay a bonus in cash instead of through payroll?

No. Cash payments to employees are still employment income and must go through payroll with withholdings calculated and remitted. Paying in cash without processing through payroll is an illegal payroll practice and exposes you to IRS and EDD penalties.

Is a signing bonus treated the same as a performance bonus?

Yes, for tax purposes, both are employment income subject to the same withholding rules. Signing bonuses may have clawback provisions if the employee leaves within a certain period; document this in the offer letter if applicable. Note that California courts scrutinize clawback provisions carefully, get legal advice before building one into a signing bonus agreement.

Does a bonus count toward vacation pay accrual in California?

It depends on whether the bonus is non-discretionary (tied to a formula or metric the employee can earn) or discretionary (a surprise payment with no formula). Non-discretionary bonuses are included in gross earnings for vacation pay accrual purposes. Discretionary bonuses are not. Confirm with your NCO advisor if you're unsure which category applies.