Bonuses – a loaded word, if ever there was one. We all love a bonus; just ask the guys on Wall Street or at Canary Wharf – they can’t get enough of them.
Joking aside, if you’re lucky enough to be the recipient of one, it’s crucial to know the basics around their taxation.
Here’s what you need to know to ensure that your bonus doesn’t ultimately become the taxman’s bonus.
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Is a bonus payment subject to income tax?
You may be thinking that this isn’t a straightforward yes or no answer – and you’d be right! However, there are some general rules around bonuses, which will make this question a little easier to answer.
Aside from a few exceptions (which we’ll go into), many bonuses are obligated to pay income tax and NICs (National Insurance Contributions). This will often – but not always – be in line with the rest of your contracted regular income within any given tax year.
Bonuses are classed as supplemental income. You might get cash payments, non-cash compensation or non-financial bonuses. And, the taxation on each of them can vary – and some are even tax-exempt.
It’s important to note that non-cash/financial bonuses can take many forms with different rules for each – here are some of the key ones for you to look out for.
Medical insurance and treatment plans offered by employers to their employees can sometimes be exempt from taxation. It all depends on the health and safety legislation that the employer is subject to within their industry. The exemption can also extend to employees’ insurance and treatment while working overseas for their employer.
Medical treatment costs of up to £500 paid by an employer as part of a return-to-work plan for an employee can also be tax-free, providing that the employee meets the criteria of being medically ‘unfit for work’.
Yearly medical checks, eye tests and glasses (for display screen use) are also usually tax-free.
Some types of medical insurance and dental insurance provided by employers to employees will require certain tax obligations to be met by the employer.
Examples of these are when the employer pays the provider of the treatment or insurance directly or when the employee seeks either of these services themselves, and the employer covers the cost or reimburses their employee.
An employer may also be required to pay income tax on the classic perk of the company car. Shared company cars, cars used for business journeys only, and cars adapted for employees with disabilities are often exempt.
However, there are different rules surrounding this benefit – you can work out the taxable value on company vehicles here.
If you’re a business owner with a perks and rewards scheme, then it’s essential to request advice in this area if you’re unsure. It’s also just as essential, particularly if you’re self-employed, to ensure that you’re fully compliant when completing your own tax return.
How much tax will you have to pay on a bonus?
Most bonuses usually come in the form of an annual cash lump sum, rewarding good performance throughout the year. The much-loved Christmas bonus is the one some people know well. They’re usually taxed in line with the relevant taxation bracket your total income falls into.
With this in mind, let’s look at this example. If your normal salary is £25,000 annually, minus your personal tax-free allowance of £12,570, your taxable income will be £12,430. Of which, 20% will be deducted for income tax.
In addition (as of April 2022), a 13.25% national insurance deduction will be applied to any income over £9,880. So, in this case, the deduction will be applied to £15,120 of the income.
So, an end-of-year Yuletide bonus of £2,000, for instance, will be taxed at those same rates as it’s added on top. This means your whole bonus is within the taxable threshold. Not including any other deductions such as student loans, you’ll be left with a grand total of £1,335.
As already touched upon with non-cash/financial bonuses, there are loads of options, with many rules around them dictating how much, and if, tax is required to be paid. As an employer, it’s highly recommended that you view the comprehensive list on the GOV.UK website.
Can a bonus push you into a higher tax bracket?
If your gross income falls close to the boundary of the next tax bracket, then you might be in for a festive shock when that Yuletide bonus pushes you into the next bracket!
For example – if your regular income is £50,000 annually (just below the higher tax bracket of £50,270) and you receive a festive cash lump sum of £3,000, the majority of that bonus will spill over into the higher rate tax bracket.
That means £2,730 of the bonus will be taxed at the 40% income tax rate rather than 20%, and that’s not including any other deductions, such as NICs and student loan repayments.
It is vitally important, therefore, to be aware of the different taxation brackets. Once familiar, you can then gauge what your optimum bonus amount should be.
Do I have to pay tax on my bonus?
Aside from the exemptions already covered, there are some other circumstances where you can reduce the taxable amount on your bonus or even avoid paying tax entirely – here’s one of the most well-known ways.
A popular option to avoid paying tax on supplemental income is the sinisterly named bonus sacrifice. Sounds scary, but it can actually be a savvy move to prevent your rewards from falling prey to the jaws of the taxman.
How to make bonus sacrifice – pensions
Here’s how it works – instead of a cash reward in the here and now, an employer sacrifices the entire bonus, or part of it, and pays it directly into their employee’s pension scheme.
Whether it’s a full or part sacrifice, the amount you put forward for the scheme not only becomes tax-free but also becomes exempt from NICs.
Quite simply, the more of your bonus you sacrifice, the less tax you will have to pay on it. Not only that, but your once humble bonus is now reincarnated as a savvy investment for your future ‘state-pension-age’ self – or possibly earlier.
Even if you don’t have one of the jobs with the best pensions, it makes just as much sense to get as much of the benefit as possible.
You need to remember that the earliest age this money becomes accessible is 10 years before the official state retirement age, which currently varies depending on when you were born.
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How does paying bonuses affect an employer’s tax bill?
It goes without saying that as an employer, it is vital you notify HMRC of your employees’ bonuses – otherwise, the taxman will come knocking.
Once the bonus has been added to your employee’s regular earnings, you must deduct income tax on that amount through PAYE; the same goes for national insurance. You will also have to pay employer’s national insurance on the bonus.
In the US for instance, supplemental income such as bonuses, don’t get added on top.
Instead, they’re subject to a separate flat rate of 22%. So yes, this often means high earners in the UK are taxed a lot heavier on their bonuses than their neighbours across the pond.
Yes – it will often increase your contributions, especially if it’s a cash bonus. This will be taken at source either through PAYE or, if self-employed, through self-assessment after being added on top of your other income.
Employers and employees often favour the bonus sacrifice scheme. Not only does the employee avoid taxation altogether and is awarded an investment towards their future, but the employer is also exempt from paying NICs on the amount.
The amount saved in NICs is then sometimes passed on to the employee as a ‘secondary bonus’ – a win-win!
Yes, often they are. To get down to the real nitty-gritty on this, the full employment income manual from HMRC will give you all the advice you need.