Year-End Bonus Taxation: Aggregate vs. Percentage Method

The year-end bonus run is the payroll cycle most likely to produce a genuine problem, because it combines an unusual amount, an unusual timing, and an employee population paying close attention to their net pay.

The withholding choice is the visible question. The consequences that actually cost money are the deposit threshold, the retroactive overtime, and — for 2026 — the earnings-code coding that determines whether your Form W-2 reports qualified overtime correctly.

Two Methods, One Mandatory Override

Optional Flat Rate: 22%

Where the bonus is identified separately from regular wages, the employer may withhold federal income tax at a flat 22%.

Characteristics:

• The employee's Form W-4 is disregarded entirely — including any additional withholding amount they requested
• The employee cannot elect a different rate, and the employer cannot agree to one
• Available only if income tax was withheld from the employee's regular wages at some point in the current or prior year
• It is a withholding rate, not a tax rate

That final point is the source of most complaints. An employee whose marginal rate exceeds 22% is under-withheld and may owe at filing; one below 22% is over-withheld and gets it back. Both call payroll to report an error that is not one.

Aggregate Method

Combine the bonus with regular wages for the payroll period and withhold as though the total were one regular payment, using the employee's Form W-4 and the withholding tables.

Required where the bonus is not identified separately. Generally preferable where you want withholding to approximate actual liability, or where the employee has requested additional withholding you would otherwise ignore.

The catch: on a large bonus the aggregate method can produce a startling figure, because the system annualizes the combined amount as though the employee earned that much every period. The math is correct and the employee's refund will reflect it — but the explanation must be ready before the paycheck, not after.

The Mandatory $1,000,000 Rule

Supplemental wages exceeding $1,000,000 to one employee in a calendar year must be withheld at the highest income tax rate — 37% — on the excess. No flat-rate option, no aggregate option, no W-4 consideration.

Mechanics that matter:

• The threshold is cumulative across the calendar year, not per payment
• All supplemental wages count — earlier bonuses, option spreads, RSU vesting income, severance
• The payment crossing the threshold is split: the portion below $1,000,000 at 22%, the excess at 37%

A year-end bonus is frequently the payment that crosses this line for an executive who received equity earlier in the year. Track cumulative supplemental wages per employee before the run.

A Worked Comparison

Employee with $6,000 in regular semi-monthly wages receives a $20,000 year-end bonus. Single filer, no W-4 adjustments, illustrative figures.

The FICA columns are identical, because the method choice affects federal income tax withholding only. Social Security applies until the employee reaches the 2026 taxable maximum of $184,500; Medicare applies with no limit; the additional 0.9% applies above $200,000 in cumulative wages.

State treatment is separate: many states have their own flat supplemental rate, some require the aggregate method, and some have no separate provision at all.

Our supplemental wage payments guide covers the full framework, and Paycheck Fundamentals Training & Certification Program covers the calculation.

The Deposit Threshold Nobody Watches

This is the item most likely to convert a bonus run into a penalty.

Any time accumulated employment tax liability reaches $100,000, the deposit is due the next business day — regardless of whether you are normally a monthly or semi-weekly depositor. It also promotes the employer to semi-weekly status for the remainder of the year and all of the following year.

A single year-end bonus payroll can do this to an employer that has been comfortably monthly for a decade. The arithmetic is not extreme: a $2 million bonus pool generates well over $100,000 in combined withholding and FICA.

Calculate the accumulated liability before releasing the run, not after. Failure-to-deposit penalties escalate by lateness and reach 10% at ten days, and the Trust Fund Recovery Penalty permits personal assessment against responsible individuals. See our How To Minimize And Eliminate Payroll Penalties session.

Non-Discretionary Bonuses Change Overtime Retroactively

The second expensive consequence, and it affects only non-exempt employees.

A non-discretionary bonus must be included in the FLSA regular rate. Where the bonus covers a period longer than one pay period, it must be allocated back across the weeks earned — retroactively raising the regular rate for each — and additional overtime premium is owed for every one of those weeks in which the employee worked over 40 hours.

An annual bonus paid to non-exempt employees therefore generates a retroactive overtime calculation across 52 weeks. Most payroll systems do not perform it automatically.

Which bonuses are excludable? Only genuinely discretionary ones, where the fact of payment, the amount, and the timing are all at the employer's sole discretion and not promised or announced in advance. Announcing the criteria makes a bonus non-discretionary regardless of what the plan calls it — so "everyone who hits target gets a year-end bonus," said in a meeting in March, is non-discretionary in December.

See our how to calculate overtime pay walkthrough and the DOL rules on overtime session.

2026: Bonuses Are Not Qualified Overtime

Under the One Big Beautiful Bill Act, beginning with the 2026 tax year employers must separately report qualified overtime compensation on Form W-2.

The point that matters for a bonus run: overtime-style bonuses do not qualify. Only the premium portion of overtime mandated by Section 7 of the FLSA counts. A bonus rewarding extra hours, a weekend incentive, or a shift premium is not qualified overtime no matter what it is called internally.

If your system posts premium-style bonuses into an overtime earnings code, you will over-report qualified overtime on the Form W-2. Verify the coding before the bonus run rather than discovering it in January. See our OBBBA payroll forms update session.

Everything Else the Bonus Run Touches

• Social Security wage base. A bonus frequently pushes an employee across $184,500 mid-run — verify OASDI stops at the ceiling
• Additional Medicare. A bonus frequently crosses the $200,000 cumulative threshold, triggering the additional 0.9%
• Retirement deferrals. If the plan's compensation definition includes bonuses, deferrals apply — and a large bonus can push a participant to the annual deferral limit mid-run. Confirm the plan's definition. See our 401(k) plan administration guide.
• Disposable earnings rise with the bonus, so the garnishable amount rises. Applying the routine periodic amount under-withholds. See our employer's guide to wage garnishments.
• Child support lump-sum reporting. Many states require reporting a lump sum payment to the child support agency before disbursing it where the employee has arrears. Disbursing without required notice can create liability for the amount that should have been intercepted. See our child support withholding guide.
• Benefit deductions. Confirm whether percentage-based deductions apply to the bonus, and whether that is intended.

Explaining It Before the Paycheck

The bonus run generates more employee contact than any other payroll cycle, and nearly all of it is avoidable with one advance communication.

The complaint you will receive: "My bonus was $10,000 and I only got $6,200. Why was I taxed at nearly 40%?"

The accurate answer, which needs to be delivered proactively rather than defensively:

• 22% is federal income tax withholding, not the tax rate. It is an estimate, and the actual liability is settled on their return.
• Social Security at 6.2% and Medicare at 1.45% apply on top, as they do to all wages.
• State income tax applies per that state's supplemental rules.
• Together those routinely reach 30–40% of the gross, and none of it is an error.
• If the employee's marginal rate is below 22%, they are over-withheld and will receive the difference back.
• If it is above 22%, they are under-withheld and should plan for it — which is genuinely useful information delivered in December rather than April.

What not to say. Do not tell an employee the bonus was "taxed at a higher rate" — that reinforces the misconception. And do not offer to adjust the withholding, because under the flat-rate method you cannot.

A practical approach. Send a short note with the bonus announcement, before the payroll runs, explaining that withholding on bonuses uses a flat federal rate that may differ from their usual rate, listing the components, and stating that the final tax is determined on their return. One paragraph, sent once, replaces dozens of individual conversations.

Where the aggregate method is used, the communication matters more, not less. Aggregate withholding on a large bonus can look punitive because the system annualizes the combined amount. Employees seeing a 35% federal withholding figure will assume an error unless told otherwise in advance.

A Pre-Bonus-Run Checklist

• [ ] Decide and document the withholding method, and confirm the bonus is identified separately if using the flat rate
• [ ] Check cumulative supplemental wages per employee against the $1,000,000 threshold
• [ ] Calculate accumulated deposit liability and check the $100,000 next-day rule
• [ ] Identify which bonuses are non-discretionary and compute the retroactive overtime for non-exempt employees
• [ ] Verify the bonus earnings code is not treated as qualified overtime
• [ ] Identify employees crossing the Social Security wage base or the $200,000 Additional Medicare threshold
• [ ] Confirm the state supplemental withholding method for each work state
• [ ] Confirm retirement plan treatment per the plan's compensation definition
• [ ] Recalculate garnishments on the higher disposable earnings
• [ ] Check for child support lump-sum reporting obligations before disbursing
• [ ] Prepare the employee communication explaining the withholding
• [ ] Reconcile the run before releasing

Frequently Asked Questions

How are year-end bonuses taxed?

A bonus is supplemental wages. The employer either withholds federal income tax at the optional flat rate of 22%, if the bonus is identified separately from regular wages, or uses the aggregate method, combining it with regular wages and applying the employee's Form W-4. Social Security, Medicare, Additional Medicare, unemployment taxes, and state withholding all apply normally regardless of which federal method is chosen.

Which is better, the flat rate or the aggregate method?

Neither is universally better. The flat 22% is simpler and predictable but disregards the employee's W-4 entirely, so it under-withholds for employees above that marginal rate and over-withholds for those below. The aggregate method approximates actual liability more closely but can produce a startlingly high figure on a large bonus because the system annualizes the combined amount. The aggregate method is required where the bonus is not identified separately.

Can an employee ask for a different withholding rate on a bonus?

No. The employer chooses between the flat rate and the aggregate method, and the employee cannot elect a different rate. Under the flat-rate method the employee's Form W-4 is ignored entirely, including any additional withholding they previously requested. An employee wanting more withheld can adjust their W-4 for regular wages, but not for a flat-rate supplemental payment.

What is the tax rate on bonuses over $1 million?

Supplemental wages exceeding $1,000,000 to one employee in a calendar year must be withheld at 37% on the excess, with no optional method and no regard to the Form W-4. The threshold is cumulative across the year and includes all supplemental wages — earlier bonuses, option spreads, RSU vesting income, and severance — so the payment that crosses it is split, with the portion below $1,000,000 at 22% and the excess at 37%.

Do year-end bonuses affect overtime pay?

Non-discretionary bonuses do. They must be included in the FLSA regular rate, and a bonus covering more than one pay period must be allocated back across the weeks earned — so an annual bonus generates a retroactive overtime calculation across 52 weeks for any non-exempt employee who worked overtime. Only genuinely discretionary bonuses are excludable, and announcing the qualifying criteria in advance makes a bonus non-discretionary regardless of its label.

Can a bonus payroll trigger a next-day tax deposit?

Yes, and this is one of the most common bonus-run penalties. Any time accumulated employment tax liability reaches $100,000, the deposit is due the next business day regardless of your normal schedule, and the employer becomes a semi-weekly depositor for the rest of the year and all of the following year. Calculate accumulated liability before releasing the run rather than after.

Going Deeper

• Supplemental wage payments — the full supplemental framework
• Paycheck Fundamentals Training & Certification Program — withholding mechanics
• Payroll Wage & Hour Training & Certification Program — regular rate and retroactive overtime
• Payroll year-end checklist — where the bonus run fits

Flat rates, wage bases, and thresholds are federal figures that can change with legislation, and state supplemental rules vary widely. Verify current figures against IRS Publication 15 and each state's agency before the bonus run.