5 Tax Strategies for Unexpected Income

Receiving a cash bonus for a job well done is always a cause for celebration. However, it’s important to remember that along with that extra money comes the inevitable tax implications. The Internal Revenue Service (IRS) considers bonuses to be supplemental wages, which means that your employer is required to withhold 22% of your bonus right off the bat. This withholding can come as a surprise to many individuals, especially if they were not expecting to owe taxes on their bonus.

While you may be able to recoup some of the withheld amount at tax time, there are other factors to consider when it comes to the taxation of bonuses. For example, receiving a bonus could potentially bump you into a higher tax bracket, which could result in you owing even more in taxes. Additionally, if you work in multiple states throughout the year, you may be required to pay taxes on your bonus to each state.

To help you navigate the tax implications of receiving a bonus, here are five strategies that may help you keep as much of that extra cash as possible:

1. Set It Aside for Later: Consider using your bonus to jumpstart your retirement savings by making a special contribution to a qualified retirement savings account, such as a 401(k) or traditional IRA. This can help reduce your taxable income and set you up for a more secure financial future.

2. Defer Compensation: Look into a deferred compensation plan at work to spread out both the money you receive and the tax liability. If you are paid in shares of stock, consider the best time to cash out to offset or limit capital gains.

3. Pay Your Taxes: Use your bonus to catch up on estimated tax payments or withholding-tax obligations to avoid IRS penalties for underpayment. You may also be able to prepay next year’s real estate taxes to reduce your tax liability.

4. Give It Away: If you itemize your deductions, consider making a charitable donation to shield some of your bonus from taxes. Donor-advised funds can be a useful tool for high-net-worth individuals looking to maximize their charitable contributions.

5. Pay Your Expenses: Use your bonus to pay deductible business or personal expenses before the end of the year. Consider upgrading equipment or prepaying bills to reduce your taxable income.

It’s important to remember that no matter what strategies you employ to reduce your tax liability on a bonus, you will still owe some taxes on that extra income. Consulting with a tax advisor can help you navigate the complexities of bonus taxation and ensure that you are taking full advantage of any available deductions or credits. By being proactive and strategic with your bonus, you can make the most of that extra cash while minimizing your tax burden.