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How Bonuses Are Taxed

Many employers typically pay year-end bonuses in the first quarter of the year. If you received a bonus for the first time this year, you may be surprised at the net amount of your “windfall.”

WHY THE SURPRISE?

Work bonuses are classified as supplemental wages, which are subject to federal income tax withholding. They are also subject to Social Security and Medicare taxes, and in some cases, state taxes may apply. The IRS provides employers with specific guidelines outlining the methods for calculating federal income tax on supplemental wages.

The default rate for federal income tax withholding on bonuses less than $1 million is currently 22%, so employers can withhold at a flat rate of 22% or combine regular and supplemental wages to calculate the tax amount. That means your bonus may be taxed at your highest individual income tax rate, which could be 37%, not to mention any state tax. You may receive some of the withheld amount back as a tax refund. Check with your tax professional.

HANDLING THE INFLUX OF CASH

So, now that you’re over the tax sticker shock, what will you do with your windfall? First, reward yourself in some small way, such as a weekend away or an item you have wanted. Then, a good move is to contribute the rest to tax-advantaged accounts such as a 401(k), IRA or Health Savings Account (HSA). By contributing part of your bonus to these accounts, you save for your future and may offset some of your tax bill for the year.

Another way to minimize work bonuses’ tax impact is to consider charitable contributions. Donating a portion of your bonus to qualified charitable organizations not only supports meaningful causes but also provides a deduction that could lower your taxable income.

While it won’t reduce taxes, you may want to use some of your bonus to pay off a high-interest credit card or student loan. Be careful not to become reliant on annual bonuses. In tight economic times, bonuses can be reduced or even suspended.

The choice is yours but being proactive and strategic with your bonus can lead to substantial tax savings and long-term financial benefits.

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December 2024 Client Line Newsletter

How Bonuses Are Taxes – if you received a bonus for the first time this year, you may be surprised at the net amount of your ‘windfall’.

Plan For A Cash-Only Holiday – tips to keep holiday spending under control.

Year-End Tax Planning – here are some year-end strategies that may help cut your tax bill.

Don’t Be Your Own Worst Investing Enemy – many investors aim to have their gains match or beat a standard investment benchmark.

December 2024 Client Profile

Health Insurance Deduction For Self-Employed – health insurance is one of the many reasons being self-employed is not for everyone.

December 2024 Question and Answer

Track Your Dollars – tracking your expenses will help you take control of your financial life.

Year-End Tax-Saving Opportunities – a brief checklist of moves you can make to help reduce current or future tax exposure.

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Growing Self-Employment Jobs

This chart shows the expected employment growth in the various occupations from 2022-2032.

Note: Projected employment growth is for all workers in an occupation, not only for those who are self-employed.

Source: U.S. Bureau of Labor Statistics, Office of Occupational Statistics and Employment Projections

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Budget-Saving Holiday Travel

Americans usually travel during the holidays and it can be expensive. Here’s how to save money on the ground and in the air.

ROAD TRIP

Gasoline costs often rise during the holidays, so look for savings. Some wholesale buying clubs sell gasoline at discounts. You can also look for apps that alert you to the lowest gas prices wherever you travel.

If you expect to travel for hours, pack sandwiches, snacks, and games to keep the kids content. If you need lodging, use rewards cards if the establishment offers lower prices for members. Also, look for coupons for your favorite hotel when using rest stops on major highways and interstates.

BY AIR

Look to fly during off-peak hours, including on the holiday itself, for some of the lowest airline fares. Check the airline website’s baggage guidelines to avoid unexpected fees at check-in, which is usually more expensive than booking ahead of time.

COMBO

Enlist family and friends to pick you up from the airport, if possible. If you have to rent a car at your destination, don’t buy insurance if your auto insurer already provides rental coverage.

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Paying Taxes When You’re Self-Employed

Whether you have just started a side hustle or have been freelancing for years, filing taxes can present challenges. Here are some points to keep in mind.

YOUR BUSINESS STRUCTURE

As a freelancer, you can set up your business as a sole proprietor or a Limited Liability Company (LLC). An LLC can be taxed as a sole proprietorship or as a corporation.

SELF-EMPLOYMENT TAXES

If you’re new to freelancing, you might be surprised to learn that you’re on the hook for both the employee and employer share of FICA taxes. FICA tax equals 15.3% of income — 12.4% for Social Security and 2.9% for Medicare. If your income is greater than $200,000 ($250,000 married filing jointly/$125,000 filing separately), an additional Medicare tax of 0.9% applies.

QUARTERLY TAX PAYMENTS

Freelancers, small business owners, and independent contractors generally must make quarterly estimated tax payments to the IRS to avoid being subject to an underpayment penalty.

REPORTING THRESHOLD

Once the total exceeds $600, you will receive a 1099-K for any transaction settled through third-party payment networks (credit cards, debit cards, etc.). The amount doesn’t have to come from a single transaction.

CUT TAXES WITH A RETIREMENT PLAN

Self-employed individuals can reduce the amount of taxes they owe by contributing to a qualified retirement plan. A SEP (Simplified Employee Pension Plan) has a high contribution limit — 25% of net earnings, up to $69,000 for 2024.

A SIMPLE (Savings Incentive Match Plan for Employees) IRA allows you to put all your net earnings from self-employment into the plan, up to a total of $16,000 or $19,500 if 50 or over.

OTHER POTENTIAL DEDUCTIONS

You may deduct what you spend on: continuing education, vehicle expenses, home office expenses, internet and phone service, travel to business meetings and conferences, and interest on business loans.

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November 2024 Question and Answer

QUESTION

I have a life insurance policy that names my son as beneficiary. Should I also include this policy in my will?

ANSWER

It wouldn’t hurt anything, but no, you don’t. That’s because life insurance beneficiary designations take priority over terms of a will, even if they differ. The same holds true for the beneficiary designations of retirement plans and annuities. This is a good time to remind you that keeping all your beneficiary and contingent beneficiary designations current would be best. If you’re interested in your beneficiaries getting the most from the benefit without triggering estate taxes, or you want to avoid the public glare of probate, you might consider putting the life insurance policy in a trust.

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U.S. Citizens Give Generously

Americans gave an estimated $557.16 billion to U.S. charities in 2023, according to Giving USA 2023: The Annual Report on Philanthropy for the Year 2023 (from the Giving USA Foundation, the Giving Institute, and the Indiana University Lilly Family School of Philanthropy). The total includes charitable contributions from individuals, estates, foundations, and corporations.

HOW TO CHOOSE

If you want to give to an organization that makes the most of your charitable giving, learn how much of each dollar goes toward the charity and how much is spent elsewhere. You can find some organizations with websites that evaluate the legitimacy of charities and how they spend contributions.

Also, look for a charity’s IRS Form 990 and ask to see its audited financial statement to ensure it meets your desired standards. Match your giving objectives with a charity’s mission and demonstrated results. Look for charities that best match your values.

GET HELP

If you make significant charitable contributions, consider enlisting the aid of your advisor and an estate planning attorney. Although the federal estate tax exclusion is higher than in the past, some families may exceed it while also dealing with lower state estate and inheritance tax thresholds. Structured properly, charitable giving can benefit your charity and reduce estate taxes.

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November 2024 Client Profile

William’s business is tourist-dependent and earns most of its money during the warmer months. He has always filed his tax return based on the calendar year but would like to change it to a fiscal year ending in October. What does he need to do?

First, William should make sure he is eligible. The IRS says if you file your first return using the calendar tax year and later become a sole proprietor, a partner in a partnership, or a shareholder in an S corporation, you must continue to use the calendar year unless you get IRS approval to change it or meet one of the exceptions listed in its Form 1128 instructions.

William may qualify for automatic IRS approval to change his tax year. A tax professional can help determine whether changing the tax year is the right course of action.

Client Profile is based on a hypothetical situation. The solutions discussed may or may not be appropriate for you.

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How to Attract Older Workers

Choosing a benefit package attractive to employees of every age is often challenging, especially when an employer has an older workforce. Numbering roughly 11 million today, the older workforce has nearly quadrupled in size since the mid-1980s.

OFFER FLEXIBILITY

As your workforce ages, consider how older workers value flexibility as much as health and retirement benefits.

Larger organizations increasingly allow older workers to transition into retirement by job-sharing, working remotely, and cutting their hours. Some pioneering snowbirds work seasonally with one employer or in temporary jobs, as income needs dictate, while they travel back and forth between their northern homes and the Sunbelt.

GAIN EXPERTISE

Other companies that know age often equals knowledge may attract older workers by offering paid healthcare, long-term care, and generous paid time off. As the workforce ages, consider taking the lead by hiring older workers. They equal experience and productivity.

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How to Take Friendly RMDs

Before you retire, consider planning for your required minimum distributions (RMDs). This can be more complicated than you imagine if you have significant retirement assets in qualified plans, but with a little planning, you can achieve a tax-friendly result.

KNOW THE RULES

Retirees can wait until April 1 of the year after their 73rd birthday to begin taking withdrawals. In 2033, the age for taking RMDs will increase to 75. There is a penalty tax for missing a required withdrawal.

CONSIDER THESE MOVES

Converting some traditional IRA assets to a tax-free Roth IRA during lower-income years to limit the future income tax bite (you’ll pay ordinary income tax upon conversion). You can also invest some IRA money in a Qualified Longevity Annuity Contract (QLAC), which can delay required payments for several more years.