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It feels great to get a raise or bonus; but, you still have to pay the tax man. Here's how to do it without spoiling all the fun.
Good news: Your employer likes the work you are doing and your company had a good year (or they were just feeling generous). Whatever the case may be, you received a bonus or raise this year. Now comes the hard part, deciding what to do about the taxes you owe on your higher income.
You Received a Raise
The increased income may push you into a higher tax bracket, which might make it necessary to adjust your income tax withholding. You do this by changing the number of withholding allowances you claim on the Form W-4 you file with your employer. To calculate the correct number of allowances, you can use the schedule in the instructions to Form W-4.
For a more sophisticated tax withholding analysis, use our Paycheck Withholding Calculator; it's specifically designed to help you determine how many withholding allowances you should claim. Not only that, it estimates your total income, deductions, and tax liability for the year.
You Received a Bonus
Bonuses are often distributed outside of the normal payroll process, which means they might not be subject to federal or state tax withholding. If you are unsure about whether taxes were withheld on your bonus, ask your employer.
If taxes were withheld, you may be okay. Then again, if the bonus pushes you into a higher tax bracket, the withheld taxes may not be enough to cover the entire tax liability associated with the bonus. A good way to determine whether you have enough tax withheld is to use the Paycheck Withholding Calculator, described above.
If taxes were not withheld, you need to decide how to pay the taxes associated with the bonus. Many people will just wait until their tax return is due in April to pay the tax on a bonus. This method is fine, as long as you are sure you will have the money to pay the taxes and as long as there isn't so much tax due that the IRS charges interest and tax underpayment penalties.
Another way to pay the tax associated with a bonus is to make a separate tax payment directly. This is called an estimated tax payment. To determine if you are required to make such a payment, read the article Determining Your Estimated Tax Payments.
Timing Your Bonus
If you have some flexibility regarding the date you will receive your bonus, and it is near the end of the year, you may want to ask that the bonus be paid to you in whichever year you are in a lower income-tax bracket. This will reduce your overall tax liability because you will pay tax at a lower rate on the bonus income.
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