Help a Reader: Tax Accounting for a Bonus

Here's an email I recently received from a reader:

I'm anxiously waiting to get my tax documents so I can work on my return.  Last year I nailed my withholding estimates - we got a small fed refund and owed a bit for our state return.  The net was that we underpayed by ~ $150.  I'm expecting a refund this year though because last year, for the first time in ages, I received a bonus.  My company pays the bonus in Q1 for achievement in the prior year.  I don't like getting a refund - how can I best account for this event in tax planning in 2014?

The bonus comes as payment with your regular check.  If I know the expected bonus amount, should I adjust my W-4 before that paycheck or should I recalculate my withholding for the rest of the year after I get that check?  How have others handled this situation?

Based on the tax withholding it looks like I was taxed last year on that check at ~ 37%.  I figured out that the additional amount in the check resulted in ~ $2000 of additional withholding vs. what I would have had withheld if those bonus dollars had withholding equal to what was withheld on a regular paycheck around the same timeframe.

What's your advice for him?

Comments

[elb]

For 2013? Nothing, the bonus was already paid to you and realized and the withholding already made. Pay what you owe or take your refund.

Going forward, 25% is the proper withholding amount (federal) for bonuses, provided you total income is below $1m. In the case of a substantial bonus, don't worry about adjusting the W-4, just hold 10-15% of the gross bonus in cash until you are close enough to the end of the year to estimate your taxes.

[elb]

(above is in most cases, some employers classify the bonus as regular wages and withhold accordingly, in which case you should use the IRS estimator to track where you are at on a periodic basis throughout the year)

[Lurker Carl]

After receiving your 2014 bonus, submit a new W4 to reduce tax withholdings from your regular pay until the overage is made up. Then submit another W4 that returns to your previous withholding rate.

[Bill]

Go to Dinkytown and use the tax calculator to figure out how much your taxes will be for this year (using 2013 tax laws as a close estimate), adjust for changes you know are going to happen this year and then adjust your w4 using the withholding calculator as Lurker Carl suggests. I do this every year and I usually get pretty close.

[Sarah]

Given current risk-free rate, query whether this game is worth the candle. Especially given that there are, potentially, penalties for underpayment. If you are now making enough to bring yourself within the icy shadow of AMT, getting your withholding right will require professional advice.