A workplace bonus is a great thing. Perhaps you worked extra hard or handled an important project for your employer. Maybe you just helped your organization make extra profits. Whatever the reason, though, that bonus could cause trouble at tax time. How can you avoid letting a salary windfall turn into an unnecessary tax bill? Here are a few steps to take before you get that check.
1. Find Out About Withholding.
In general, the withholding tax on bonuses takes one of two forms. If the bonus is a separate check, it may be taxed at a special rate for supplemental wages — currently 24 percent. If part of your regular paycheck, the withholding tax rate is the same as your other wages. Find out how your employer will pay this money and whether you can request a different method. Then, consult with your tax accountant about which method is best for you.
2. Boost Deductible Contributions.
Once you know you'll receive a windfall, work to lower the taxable amount by increasing deductions. The more of that bonus money you put into nontaxable accounts, the fewer taxes you'll pay. The easiest places to start are usually increasing your 401(k) deductions, opening a traditional IRA, or contributing to a Health Savings Account (if you qualify).
3. Negotiate Alternatives.
Because your employer is happy with your work, consider negotiating for more tax-advantaged benefits instead of cash. While a big bonus in one year throws off your taxes that year, better benefits could actually help your finances for many years. Perhaps the company is willing to trade some or all of that bonus for increased (nontaxable) health insurance subsidies, a remote or flexible work schedule, life insurance, or the use of a company vehicle.
4. Start a Side Gig.
How you use that bonus can also reduce your taxes. Have you thought about starting a side gig for a secondary or passive income stream? Now may be a great time to jump in. If you use this money to pay expenses for starting a small business or doing work as an independent contractor, it could generate a loss on Schedule C which you may use to offset other taxable income.
5. Pay In Advance.
Perhaps you need the bonus money in hand to pay expenses or pay off debt. Once tax reduction strategies are completed, take one final step to ensure you don't end up with a tax bill. This step? Make sure you've paid enough in withholding for the year that you have covered your tax obligation. It's better to pay taxes when you get the check than on April 15 when cash may be low.
Which of these tax strategies could you use to make the most of your big bonus? Start determining this by meeting with an accountant in your state before you receive it. For more information, reach out to a tax strategy service such as HolyOak & Co.