Bonus Checks and Federal Witholding

[TarpleyG]

Okay, here's the scoop.  I always hear of folks adjusting their W4 a month or so before getting a bonus check to increase the number of allowances so there is less federal witholding taken out.  Nobody at work has ever done this (at least in my group) and I am looking for some input from some of you that have done this.  Does it help that much?  How many allowances can you have before you get into trouble (I hear 10 or more and the company has to report to the IRS)?  Is this even legal?  I already plan to turn off my 401(k) deduction just ahead of time to save that money for my bonus.

Oh, we are planning a big out of state move next year so ever penny counts if you are wondering why I am concerned.  Normally I don't really care but I cannot wait until next April for this money.

Greg

[Paddy]

I think it's at 10 exemptions that your employer is required to send a copy of your W-4 to the IRS.  The worst that will happen is an underpayment penalty, but that could be mitigated by filing a 2210 with your return since the bonus is very late in the year, the penalty would be small.

You don't have to wait until April 15th for any refund; you can file as early as you get all your earnings and withholding information, no later than the beginning of February.  That way, you'll have any refund due you within 2-3 weeks.

[TarpleyG]

Bonus is not paid until February...I didn't make that clear before.  That means the money is tied up for a year or so (2007).

Greg

[Paddy]

OK.  You can use this Withholding calculator to get it just right so that you essentially break even at the end of the year.

[garrettwc]

Tarpley, something else to consider.

What is the bonus based on? Solely on your performance, or on your company's performance as well.

In the case of mine, it is based half on my performance, and half on the company's performance vs. their target earnings number for the year when they report fiscal earnings to the SEC. If we are under/over the target number our bonus is decreased/increased by a similar percentage. Because of that latter basis, our bonus is treated not as standard wages for witholding, but as short term capital gains and the government is going to take about half of it regardless of how many exemptions you claim.

[TarpleyG]

It has always been treated as an additional paycheck and it is a percentage of my regular salary based mostly on individual performance and partially on company performance.

[garrettwc]

If it has always been taxed at your normal tax rate rather than the 40+% capital gains rate then RileyMc has given you the right path.