What to do if you receive the wrong W-2 Form?

If you receive a notice about an employer who has a W-2 for your taxpayer that they didn’t work at – and this usually happens in the fall, say from June through November – our underreporter unit will go through and they will match up the W-2s against the tax returns, and they will find that one is missing. And let’s say that this W-2 comes in and it’s out of North Carolina, and this person made about $20,000 in North Carolina. Your client only made $30,000 all year, so, of course, our underreporter is going to kick out and say, “Hey, most of your income wasn’t reported. You’ve got this big chunk out here.” Well, your client is going to look at it and they are going to say, “I didn’t earn this income.” The best thing they can do is call back the number on the letter and say, “I didn’t earn this income.” We need to know that. We need to know the information has been compromised so we can mark their account that they are at risk for identity theft. It is very important. Some people just go ahead and ignore it. And what happens if they ignore it, it gets assessed. Then you start getting collection letters. And it is harder to get out of collection once it has been assessed than it is to stop it from getting assessed in the first place.


I received an incorrect W-2 form. My former employer won’t issue me a corrected W-2. What should I do?

If your attempts to have the incorrect Form W-2 Wage and Tax Statement, corrected by your employer are unsuccessful and it is after February 14, you can request that an IRS representative initiate a Form W-2 complaint.

  • The IRS will send your employer a letter requesting that they furnish you a corrected Form W-2 within ten days. The letter advises your employer of their responsibilities to provide a correct Form W-2 and of the penalties for failure to do so.
  • The IRS will send you a letter with instructions and Form 4852 (.pdf), Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. You can use the Form 4852 in the event that your employer does not provide you with the corrected Form W-2 in time to file your tax return.

When you call the IRS or visit a TAC office, please have the following information available:

  • Your employer’s name and complete address including ZIP code, employer identification number if known (see prior year’s Form W-2 if you worked for the same employer) and telephone number,
  • Your name, address including ZIP code, Social Security number, and telephone number, and
  • An estimate of the wages you earned, federal income tax withheld, and the period you worked for that employer. You should base the estimate on year-to-date information from your final pay stub or leave-and-earnings statement, if possible.

Form 4852 and Form W-2

If you file your return and attach Form 4852 to support the withholding amount claimed instead of a Form W-2, there may be delays processing your refund while we verify the information you gave us.

If you receive a corrected Form W-2 after you filed your return and it does not agree with the income or withheld tax you reported on your return, file an amended return on Form 1040X (.pdf), Amended U.S. Individual Income Tax Return.

What is IRS Civil Fraud Penalty?

Due to its steep rate, the civil fraud penalty is one of the most powerful tools that IRS has. It applies if any part of a tax underpayment is due to fraud, and the penalty equals 75% of that portion of the underpayment attributable to fraud. Although IRS has the burden of proving fraud by clear and convincing evidence, if it shows that any portion of an underpayment is due to fraud, the entire underpayment is treated as  attributable to fraud except for any portion  hat the taxpayer shows (by a preponderance of the evidence) not to be so attributable.


What is IRS Civil Fraud Determination?

Other adverse results also flow from a civil fraud determination. For example, no time limit exists on the assessment and collection of tax if a fraudulent return is filed. Likewise, a return subject to the civil fraud penalty is treated as fraudulent for bankruptcy purposes. As a result, taxes shown on such a return are not normally discharged in a bankruptcy proceeding. This can be of very serious consequence to a tax payer who is trying a new start.


Definition of IRS Civil Fraud?

What is Civil Fraud? Although civil fraud is not defined by statute, some courts have defined it as an actual and deliberate, or willful, wrongdoing with specific intent to evade a tax believed to be owed. Fraudulent intent is rarely shown by a single act or by direct proof of a taxpayer’s intent. Instead, it’s usually shown by looking at all of the facts and circumstances.


What is the IRS Civil Fraud Penalty?

The civil fraud penalty does not apply if no underpayment exists or if no return is filed. However, a separate fraudulent failure to file penalty, imposed at a maximum rate of 75%, may apply to late-filed or non-filed returns.


Defenses of Civil Fraud Penalty

Certain constitutional defenses to the civil fraud penalty, including double jeopardy, have been rejected because the penalty is civil and not criminal in nature. The tax law clearly provides that the reasonable cause and good faith defense, which is available against certain accuracy related penalties such as the negligence penalty, is also available against the civil fraud penalty, but the usefulness of the defense is limited because the fraudulent intent that is required for imposition of the civil fraud penalty is difficult to reconcile with reasonable cause and good faith.


How to Defend IRS Civil Fraud Penalty?

However, taxpayers have often been successful in avoiding the civil fraud penalty by proving that they relied reasonably on professional advice. In invoking this defense, it’s critical for a taxpayer to show that he gave complete information to his adviser and that he actually followed the advice.

Interest on Underpayment of Tax

Interest on underpayments of tax is imposed at the federal short-term rate plus three percentage points The interest rates, which are adjusted quarterly, are determined during the first month of a calendar quarter and become effective for the following quarter. Currently, in 2015 and 2016, the interest rates remain very low and paying interest on tax payments will  be of minor consequence to many taxpayers.


Interest Accruing on Tax Payments

Interest accrues from the date the payment was due, determined without regard to any extensions of time, until it is received by the IRS, although no underpayment interest accrues for failure to timely pay individual or corporate estimated tax. Interest is compounded daily. For all four quarters of 2014, the interest rate on underpayments is three percent.


Who is liable for interest on unpaid taxes?

If a carryback of a net operating loss, net capital loss, or other credit carryback eliminates or reduces a deficiency otherwise due for such earlier year, the taxpayer remains liable for interest on unpaid income taxes (including deficiencies later assessed by the IRS) for the carryback year. The entire amount of the deficiency will be subject to interest from the last date prescribed for payment of the income tax of the carryback year up to the due date (excluding extensions) for filing the return for the tax year in which the loss or credit occurred


Overlapping Overpayments and Underpayments

The interest rates for overpayments and underpayments have been equalized for any period of mutual indebtedness between taxpayers and the IRS

Abatement of Interest. The IRS has the authority to abate interest in cases where the additional interest was caused by IRS errors or delays. However, the IRS may act only if there was an error or delay in performing either a ministerial act or a managerial act, including loss of records by the IRS, transfers of IRS personnel, extended illness, extended personnel training, or extended leave, and only if the abatement relates to a tax of the type for which a notice of deficiency is required.


What type of taxes are affected?

These taxes would be those relating to income, generation-skipping transfers, estate, gift, and certain excise taxes, but not employment taxes or other excise taxes. Taxpayers requesting an abatement of interest generally must file a separate Form 843 for each tax period for each type of tax with the IRS Service Center where their tax return was filed or, if unknown, with the Service Center where their most recent tax return was filed.


Suspension of Interest

In order to avoid the accrual of underpayment interest, a taxpayer may make a cash deposit with the IRS for future application against an underpayment of income, gift, estate, generation-skipping, or certain excise taxes that have not been assessed at the time of the deposit. To the extent that a deposit is used by the IRS to pay a tax liability, the tax is treated as paid when the deposit is made, and no interest underpayment is imposed. Furthermore, if the dispute is resolved in favor of the taxpayer or the taxpayer withdraws the deposited money before resolution of the dispute, interest is payable on the deposit at the federal short-term rate.

IRS Penalty Case 6694(a)

For returns and claims for refunds prepared after May 2007, a tax return preparer who prepares a return or claim for refund may be liable for a penalty in the amount of $1,000 if a position is taken on the return or claim for refund and the preparer knew, or reasonably should have known, of the position, there was not substantial authority for the position, or the position was not disclosed or there was no reasonable basis for the position. Now, for 6694(a) penalties, substantial authority has the same meaning as in the accuracy-related penalty regulations.


Proving IRS Penalties

the government has the burden to produce sufficient evidence to establish the penalty applies to him. But the preparer has the burden of proving that the position taken on the return or in a claim for refund of income taxes would, number one, have a realistic possibility of being sustained on its merits, or that there was reasonable cause for the position and that such position was maintained in good faith, or that the position was adequately disclosed. The preparer also has the burden of proving the absence of negligence


IRS Code Section 6694(a)

Solely for purposes of 6694(a), the return preparer will still be considered to have met the standard concerning an unreasonable position if he relies in good faith and without verification on the advice of another advisor, another return preparer, or another party. Factors used for that good faith reliance on the advice of another are found in the regulations.


Recovering IRS Penalty

But the code in the regulations provide that no penalty under 6694(a) will be imposed if there is reasonable cause for the understatement and the preparer acted in good faith. Generally, a preparer is found to have acted in good faith if the preparer relied on the advice of a third party, and the preparer had reason to believe that the third party was competent to render that advice.


IRS Penalty Code Sections

IRC 6038(b) – IRC Section 6038(a) requires information reporting with respect to certain foreign corporations (Form 5471) and describes the information required to be reported on this form. IRC Section 6038(b)(1) provides for a monetary penalty of $10,000 for each Form 5471 that is filed after the due date of the income tax return (including extensions) or does not include the complete and accurate information described in Section 6038(a).

IRC 6694(a) – This is the Internal Revenue Code section which includes the regulations regarding return preparer penalties.

IRC 6694(b) – Return preparers who prepare a client return for which any part of an understatement of tax liability is due to the return preparer’s willful, reckless or intentional disregard of rules or regulations by the tax preparer, can be assessed a minimum penalty of $5,000.


Trust Fund Recovery Penalty (TFRP)

What is the Trust Fund Recovery Penalty (TFRP)?

To encourage prompt payment of withheld income and employment taxes, including Social Security taxes, railroad retirement taxes, or collected excise taxes, Congress passed a law that provides for the TFRP. These taxes are called trust fund taxes because the employer holds the employee’s money in trust until making a federal tax deposit in that amount. The TFRP may apply to you if these unpaid trust fund taxes are not immediately deposited by the business.


TFRP Taxes

The TFRP may be assessed against any person who is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes, and who willfully fails to collect or pay them. It is very important for employers to accurately report and pay employment taxes.


What are employer trust fund taxes?

Generally, the federal income tax, Social Security tax, Medicare tax amounts withheld by an employer from his employees’ paychecks are considered trust fund taxes. The employer holds those amounts in trust and should be remitted to the Treasury. Each employee receives full credit for these trust fund taxes withheld from your paycheck even if the employer fails to pay them over to the Treasury. The employer’s matching portion of the Social Security and Medicare taxes are not considered trust fund taxes. Social Security tax is evenly split at 6.2 percent for both the employer and the employee for the 2008 tax year example in the presentation. Medicare tax for both the employee and the employer are evenly split at 1.45 percent.


Internal Revenue Code Section 6672

Internal Revenue Code Section 6672 provides the legal basis. It states that the person must be responsible for collecting truthfully, accounting for, and paying over the tax that is withheld, and must have willfully failed to do so.In short, it is generally the individual or individuals responsible for the financial management of the business. Per Internal Revenue Code Section 6672, willfulness means that the responsible individual or individuals voluntarily, consciously, and intentionally fail to pay over the taxes. It is important to note that bad motive or intent is not necessary. Willfulness can be presumed if net payrolls were paid and the actual knowledge of the unpaid trust fund is not necessary.


Trust Fund Penalty Recovery Process

A trust fund recovery penalty dispute may be resolved through the mediation process. Fast Track Mediation is a nationwide program in which a trained Appeals mediator is assigned to help facilitate an agreement between the taxpayer and Collection while the case is still with Collection division. It is designed to conclude within 30 to 40 days after the parties agree to mediate. If no agreement is reached, the taxpayer still retains full appeals rights. Revenue Procedure 2003-41 contains the Fast Track Mediation procedures.


Who does the Trust Fund Penalty Apply to?

The trust fund recovery penalty applies when a person who is responsible to collect, account for and pay over the taxes withheld willfully and fails to pay over the trust fund. Responsibility is a matter of status, duty and authority and being responsible means the person had significant control over the corporation’s financial decisions.


Types of Recovery Processes

The rules governing disclosures are contained in IRM 11.3.40, and the appeals officer may consult with a disclosure officer to determine what could be shared with whom. The appeals officer would carefully avoid improper disclosure of any other taxpayer’s personal information, but will work with you to provide sufficient information about the issues in the case to enable you to resolve the case.

Fast Track Mediation – A nationwide program in which a trained Appeals mediator is assigned to help facilitate an agreement between the taxpayer and Collection while the case is still with the Collection division.

Post-Appeals Mediation –Post-Appeals Mediation is currently available through a pilot program in Atlanta, Chicago, Cincinnati, Houston, Indianapolis, Louisville, Phoenix and San Francisco. Post-Appeals Mediation takes place after settlement negotiations with Appeals are complete but unsuccessful.

Appeals Judicial Approach and Culture (AJAC)

Appeals Judicial Approach and Culture (AJAC) – The AJAC Project reinforces Appeals’ quasi-judicial approach to the way it handles cases, with the goal of enhancing internal and external customer perceptions of a fair, impartial and independent Office of Appeals. AJAC policy changes include:


Appeals Judicial Approach and Culture (AJAC)

  • AJAC clarifies the distinction between the role of Compliance and Appeals;
  • AJAC emphasizes a quasi-judicial approach so that Appeals hearing officers can focus on their core mission, fair and impartial decision making free from influence;
  • Appeals hearing officers will focus on their unique and highly specialized role of administrative dispute resolution;
  • Appeals should receive cases from Compliance that are fully developed and well documented;
  • Appeals will not raise new issues or reopen issues on which the taxpayer and Compliance reached an agreement during the examination except instances involving fraud, malfeasance of a material fact;
  • Taxpayers must fully address issues with Compliance and should only come to Appeals when they have reached an impasse;
  • Appeals will forward new issues, information or evidence submitted by the taxpayer to the originating function for consideration; and
  • Appeals will attempt to settle a case on factual hazards when the case submitted by Compliance is not fully developed and the taxpayer has presented no new information or evidence.


What is Early Referral?

Early Referral – One of the Alternative Dispute Resolution options, Early Referral is available to taxpayers whose returns are under the jurisdiction of Examination or Collection and who request a transfer of a developed but unagreed issue to Appeals while the other issues in the case continue to be developed by Examination or Collection. Early Referral can also be requested with respect to issues regarding an involuntary change in accounting, employment tax, employee plans, and exempt organizations. Regular Appeals procedures apply, including taxpayer conferences.


What is IRS Fast Track Settlement?

Fast Track Settlement – One of the Alternative Dispute Resolution options, Fast Track Settlement is designed to help the IRS operating divisions and taxpayers expeditiously resolve disputes while their cases are still in the examination or collection process. Appeals resources are used to resolve the dispute generally before the 30-day letter is issued. Fast Track Settlement may be available for factual and legal cases, including listed transactions, Compliance- and Appeals-coordinated issues, and issues that require consideration of the hazards of litigation.


What is IRS Mediation?

Mediation – One of the Alternative Dispute Resolution options, Mediation is an informal, confidential, and flexible dispute resolution process in which an Appeals officer trained in mediation techniques serves as an impartial third party facilitating negotiations between the disputing parties.


Appealing Decisions

CDP Revised Procedures – With the Collection Due Process revised procedures, Appeals will:

  • Ask Compliance to verify a CIS, if needed;
  • Ask Compliance to make the initial decision for all offers submitted during a CDP proceeding;
  • Return the offer to Compliance for final decision if CDP is withdrawn; and
  • Accept as verified any financial statement Compliance reviewed and is fewer than 12 months old

OIC Revised Procedures – With the Offer in Compromise revised procedures, Appeals will:

  • Identify the disputed issues;
  • Ask the taxpayer to substantiate his claim;
  • Identify certain compliance issues that must be remedied;
  • Refer new information to Compliance for review, if needed; and
  • Appeals will sustain a rejection only under the same basis for which the offer was rejected.


Innocent Spouse Relief for 2015 Taxes

Many married taxpayers choose to file a joint income tax revenues due to certain benefits this filing status of the declaration gives the taxpayer. By filing a joint return, both taxpayers are jointly and severally liable for such taxes and any tax, interest or additional penalties resulting from the joint statement, even if subsequently divorced.


What does joint and several liability mean for taxes?

The joint and several liability means that each taxpayer is legally responsible for any taxes owed.Therefore, both partners usually are held responsible for any taxes owed, even if one spouse earned all income or improperly claimed deductions or credits. This is also true even if a divorce decree states that a former spouse will be responsible for the entire amount owed on previously filed joint returns. In some cases, however, a spouse can get relief from this joint and several liability.


There are currently three types of relief joint and several liability for spouses joint statements:

  1. Innocent Spouse Relief provides you relief in situations that have assessed additional taxes if your spouse or former spouse stated income, stated incorrectly or improperly claimed deductions or credits.
  2. Relief for Separation of Duty owed ​​additional taxes prorated between you and your former spouse, or current spouse from whom you are separated because some item was not declared correctly in the joint statement. The amount of taxes that is assigned to you is the amount of which you are responsible.
  3. Equitable Relief may apply if you do not qualify for innocent spouse relief or separation of liability due to any stated incorrectly in the joint statement and is generally attributable to your spouse heading. You might also qualify for equitable relief if declared the correct amount of tax on the joint return, but no tax is paid with the statement.


Requesting Innocent Spouse Relief

Note: You must request innocent spouse relief or relief of separation required no later than 2 years after the date the IRS first attempted charge you taxes owed. For equitable relief, you have to apply for relief during the time the IRS has to charge you the tax.


How to Request Innocent Spouse Relief

If you wish to request a refund of the tax paid, then your application must be made ​​within the period of time that is given to you to claim a refund, which is generally three years after the date on which the statement or two presents years after payment of the tax, whichever is later. To see additional restrictions on redemptions available under the innocent spouse relief, equitable relief, and based on the laws of relief community property, see Publication 971, Innocent Spouse Relief (Innocent Spouse Relief) in English . No refunds are available under the relief by separation of liability.


IRS Installment Payment Options for Nonfilers

It is very important to rectify tax problems immediately if you are a non-filer or missed filing a tax return for a year.  Many nonfilers missed a year for one reason or another, and now are afraid to re-enter the tax system. But in fact, taxpayers who file overdue returns on their own are often treated reasonably well, much better than those who are caught. It is almost always in the taxpayers best interest to work with the IRS on a payment plan or an offer in compromise. Doing this as soon as possible is almost always the best option.


Installment Payment Options with IRS

For taxpayers who can’t pay their entire tax bill at once, there’s an installment payment option This is a flexible way to pay taxes that are owed and spread the payments out over a longer period. Although the taxpayer will pay interest and penalties on the amount owed, they will not have to secure outside financing to pay the taxes owed with an installment plan. The IRS will also consider an offer-in-compromise on any of the following grounds:

  1. where a taxpayer is unable to pay the tax,
  2. where there is doubt as to the taxpayer’s liability for the tax,
  3. where collection of the full amount would cause economic hardship for the taxpayer, or
  4. where compelling public policy or equity considerations exist that provide a sufficient basis for compromise.


Rejection of Offer to Compromise

An offer to compromise hasn’t been rejected until IRS issues a written notice to the taxpayer or his representative, advising of the rejection, the reason(s) for the rejection, and the taxpayer’s right to an appeal of the rejection. The IRS cannot notify a taxpayer or taxpayer’s representative of the rejection of an offer to compromise until an independent administrative review of the proposed rejection is completed. This could take some time and a taxpayer will not here from the IRS for several weeks in common circumstances.


Appealing Rejection of Offer to Compromise

After the decision is made, the taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals if, within the 30-day period commencing the day after the date on the letter of rejection, the taxpayer requests such an administrative review in the manner provided by IRS.


Streamlined offer-in-compromise program

A streamlined offer-in-compromise program is available for certain taxpayers with annual incomes up to $100,000. In addition, participants must have tax liability of less than $50,000. This is an easier to do offer-in-compromise program that will make sense for many people with smaller tax debts. The IRS has an independent procedure to review its own proposed rejection of requests for an installment agreement. This internal IRS review must occur before IRS notifies the taxpayer of actual rejection of the installment agreement request. IRS also has a procedure to allow taxpayers to appeal-to the IRS Office of Appeals-IRS’s rejection of any request for an installment agreement.


Streamlined offer-in-compromise program penalties

A $5,000 penalty applies to any person who submits an application for a compromise or an installment agreement if any portion of the submission is either based on a position which IRS has identified as frivolous, or reflects a desire to delay or impede the administration of federal tax laws. However, this penalty is clearly aimed at those who abuse the process and should not deter taxpayers with legitimate applications from using the compromise or installment agreement processes. Most taxpayers will not have to worry about facing this penalty if the submit an application to the streamlined offer-in-compromise program in good faith.


What is the IRS Audit Period?

Once a return is filed, IRS has three years in which to audit it. After that, the return is final. If no return is filed, there’s no statute of limitations. IRS can come after the taxpayer at any time, even many years later. This is the biggest reason why it is always better to file a tax return.

Some nonfilers are actually entitled to refunds. A return claiming a refund can be filed at any time, but only the tax paid within the three years before the return was filed can be recovered. Tax withheld during a calendar year is considered paid on Apr. 15 of the next year. Estimated tax is considered paid on the return due date, which is generally also Apr. 15. Thus, a return filed more than three years late will likely be fruitless as a refund claim.

When must Companies send you a W2 for Taxes?

When do you have to receive a Form w-2?

A common question that is asked frequently: Is there a date where your company has to send you your W2 by?

Employers have until 2/2/2015 to make them available (1/31 falls on a Saturday this year) by mail or electronically. If it is mailed, you should expect to receive them no later than 2/15/2015. If your address has changed, contact the employer and let them know. Employers are legally required to keep W-2 forms on file for at least four years. Employers are also legally required to fill out an employment identification number (EIN) form with the IRS.


What to do if you do not receive a W-2?

Not receiving a W2 can be a big violation of the law for an employer. Remember, things get lost in the mail and it might always work out better to contact your employer for you W2 before contacting the IRS. If you don’t have it by 2/17/2015, and you previously contacted the employers, you can call IRS customer service at 1-800-829-0922 M – F 7am – 7pm and speak with a representative. Let them know you are expecting a Form W-2, you attempted to contact the employer(s), and you have the current business address.


Filling out Form 4852

The representative will process a formal W-2 request by mail on your behalf. You will receive a letter explaining the Service’s actions, and a Form 4852Substitute for Form W-2, Wage and Tax Statement. The employer will receive a letter providing your current address and a description of the penalty for not complying with the request.


Filing Taxes with no W-2

You still must file your tax return or request an extension to file by April 15, 2015, even if you do not receive your Form W-2. If you have not received your Form W-2 by the due date and have completed steps 1 and 2, you may use Form 4852 Substitute for Form W-2, Wage and Tax Statement. Attach Form 4852 to the return, estimating income and withholding taxes as accurately as possible.  There may be a delay in any refund due while the information is verified.  You may receive your missing W-2 after you filed your return using Form 4852, and the information may be different from what you reported on your return. If this happens, you must amend your return by filing a Form 1040X Amended U.S. Individual Income Tax Return.


Information needed to create a replacement W-2 Year’s wages

If your Form W-2 never arrives, you can create your own for tax-filing purposes.

  • Payroll taxes withheld.
  • Federal and state income taxes withheld.
  • Contributions to your company retirement/401(k) plan.
  • Employer’s tax identification number.


Corrected Wage and Tax Statement. File Form W-3c

And in cases where an employer has filed for bankruptcy or ceased operations, the IRS suggests you send a copy of Form 4852 to your local Social Security Administration office. The agency’s office locator can help you find the one nearest you. This should ensure that you get proper credit for the Social Security and Medicare taxes you paid so that your checks will be correct when it comes time to collect these benefits. If you are an employer and discover an error on an employee’s Form W-2 after sending it to the SSA, submit a Form W-2c (PDF), Corrected Wage and Tax Statement. File Form W-3c (PDF), Transmittal of Corrected Wage and Tax Statements, whenever you file a Form W-2c with the SSA.

Clearing up a couple common tax misconceptions

There are many common tax misconceptions. This article attempts to clarify several big tax misunderstandings that people have:

Bonuses are taxed at the same rate as ordinary income.

It is hard to convince people that this is true, because they just take out their paystub and go “See!? You’re wrong.” However, the fact is, while your bonus check probably gets withheld at a higher rate, that check won’t be taxed differently than your other checks. There is no difference in taxes paid between someone who makes $150k/year and someone who makes $50k/year with a $100k bonus. The reason your check is withheld differently is because of the way your employer calculated how much to withhold. There are 2 ways to withhold, both of which are explained here. TLDR: Your bonus is either withheld at a flat 25% or is withheld from the table using an income of your normal monthly pay plus your bonus. The short thing to understand is, withholding will probably more than you’re used to, but any overpayment will be refunded at return time.


How are bonuses taxed by IRS?

For example, a lot of people say that bonuses are taxed at 40% instead of their normal 20-30%. So here’s a quick calculation using the 25% method. You’re going to have 25% withhold just for federal taxes. Then add 6.2% for Social Security (for income under,$117k), 1.45% for Medicare, and 5.75% for Virginia State Income Tax (I’m in VA). After all of these, you have seemingly paid 38.4% on your taxes! This is the number people like to use when complaining about bonus tax, but federal income tax is only part of it. And, this tax number is the smaller of the two ways to calculate bonus check withholding. If your employer used the aggregate method, your withholding will most likely be even higher! However, if your effective tax rate is below 25% (or the federal tax bracket used with the aggregate method), then you will see some of this money back when you file your return.


A bonus or raise to the next tax bracket almost never nets you less money.

This is a simple misunderstanding of how marginal tax brackets work. I always hear stories about getting bumped up to the next tax bracket being bad, and how they get less after tax money overall because they got bumped up a bracket. The fact is, only the extra money that puts your over the bracket line will get taxed at the higher rate.

Say you are single and make $87,800. This puts you in the 25% tax bracket, and only $50 away from the next tax bracket. Then you get a bonus of $100. $50 of your bonus will get taxed at 25%, and $50 will be taxed at 28%. The rest of your $87,800 is still taxed the same way as it would have been had you not gotten your bonus. The only way declining the bonus would be beneficial is – oh wait there is no way.


Taxation of Bonuses

While this is true for taxes, I do believe there are some instances of 100%+ marginal tax rates for low income earners who have certain tax credits that have an immediate phase out. For example, someone making $29,500 and contributing $2,000 to an IRA/401k etc has a tax credit of $200 available for them. Receiving a $50 bonus/raise would lose them that other $150 as they’re no longer eligible.

Another caveat here is that if you were utilizing any credits or deductions that are reduced or phased out at income thresholds, this can be more complex. Example: Friend who was close to the limit for taking a passive loss deduction on his rental; new salary put him over, he lost the whole deduction and his tax bill increased significantly – effectively erasing the impact of his raise on his cash flow.