Know the rules to ensure you don’t overpay taxes.

It’s been a great year, and your employees have worked hard. You decide to reward them with a small bonus as a token of your appreciation. But did you know that there are two ways in which a bonus can be given? Before you announce your good tidings to everyone, take a moment to be clear about the type of bonus you will be giving: Gross or Net. Let’s explore both ways see which best fits your needs:

Let’s say you decide to give your employee a $1,000 bonus for doing a great job. Are you issuing a $1,000 GROSS bonus or a $1,000 NET bonus? According to tax law, every payment that you issue to an employee must be taxed. If you tell your employee that s/he is getting a $1,000 bonus, but their direct deposit only comes to $700, s/he may be disappointed and your generous gesture of goodwill may soon be overlooked. To avoid any confusion and frustration, be crystal clear whether the bonus is a gross bonus or a net bonus. Your employee will then be prepared for the amount of money s/he will actually receive.

If you issue a gross bonus, then things are simple: The bonus gets taxed, the employee gets the net pay, and everything is business as usual.

Things get a bit more complex if it’s a net bonus. If you want to issue a net bonus, then you will have to tell your payroll processor to “gross up” the bonus. The payroll processor will then figure out what the gross wage equivalent of that net pay is Let’s stick with the $1,000 bonus example. If this is going to be issued net, then the payroll processor will “gross it up” to say $1,250. The $1,250 is then taxed, and it whittles down to $1,000. So the employee gets the flat $1,000 deposited into the bank.

Here’s the catch: The employee’s true bonus is not $1,000…it is actually $1,250. You essentially paid the employee a bonus of $1,250, which was then taxed. In the eyes of the IRS, the employee really received $1,250, and then paid $250 of tax over to the government. But we know that the employee didn’t really do that. So who really ends up paying the $250 in tax? You do! You end up covering the employee’s tax bill, plus you have to pay your own employer’s portion of the taxes on top of that.

Issuing a net bonus will end up costing you a lot more than what the employee receives. You may be okay with that, but it’s important that you understand your true cost so you are not caught off-guard (and can budget properly for it). So before you announce any holiday bonus this year, take a moment and give us a call. We will help you figure out your true costs and decide how you should reward your employees without breaking your bank. Contact us and let’s chat.