For employers and payroll professionals, few things are as sensitive as paying bonuses. On the one hand, bonuses are a powerful tool for motivating employees and rewarding performance. On the other, they come with tax complexities that can easily trip up employers if not handled correctly.
In California, bonus taxation involves both federal and state rules, each with its own withholding requirements. Employers who understand these rules can process bonuses smoothly, maintain compliance, and avoid payroll errors that might lead to penalties or unhappy employees.
This blog breaks down everything you need to know about handling bonus taxation in California, from federal withholding methods to state-specific rules, and from compliance requirements to best practices.
What Counts as a Bonus?
A bonus is any additional compensation paid to an employee beyond their regular wages. Bonuses can take many forms:
- Performance-based bonuses
- Holiday or year-end bonuses
- Signing bonuses
- Retention bonuses
- Referral bonuses
Regardless of the type, the IRS and California’s Franchise Tax Board (FTB) both consider bonuses supplemental wages, which means they are taxed differently from regular income.
Federal Rules for Bonus Taxation
At the federal level, bonuses are subject to income tax withholding, Social Security, and Medicare taxes. Employers have two main options for withholding federal income tax on bonuses:
1. The Percentage Method (Flat Rate)
- The IRS allows employers to withhold a flat 22% (as of 2025) on supplemental wages, including bonuses, up to $1 million.
- For bonuses exceeding $1 million, the withholding rate jumps to 37%.
This method is straightforward and often preferred for one-time payments like holiday or signing bonuses.
2. The Aggregate Method
- Here, the employer adds the bonus to the employee’s most recent regular paycheck and withholds tax based on the total amount.
- This method can result in higher withholding, especially for employees already in higher tax brackets.
Employers can choose the method, but they must apply it consistently within their payroll system.
California Rules for Bonus Taxation
In California, the state has its own rules for taxing bonuses, separate from federal guidelines. The Franchise Tax Board classifies bonuses as supplemental wages and requires state income tax withholding.
Flat Rate Withholding for Bonuses
- California requires employers to withhold a flat 10.23% on bonus payments (as of 2025).
- For stock options and other equity-related supplemental wages, the flat withholding rate is 13.3%.
This withholding is in addition to federal withholding, Social Security, and Medicare taxes.
Aggregate Method Option
Like the IRS, California also allows employers to combine the bonus with regular wages and withhold tax based on the total. However, most employers prefer the flat rate because it’s simpler and easier to administer.
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Employer Responsibilities
Handling bonus taxation correctly is about more than just knowing the rates. Payroll professionals and employers must ensure compliance at every step:
- Accurate Classification
- Treat bonuses as supplemental wages, not regular wages.
- Make sure they’re recorded properly in payroll records.
- Correct Withholding
- Apply the right federal and California withholding method.
- Remember that employees are still responsible for paying their actual tax liability at year-end, so clarity in communication is key.
- Reporting Requirements
- Bonuses must be reported on Form W-2 as part of total wages.
- Employers must also include withholding amounts for both federal and state taxes.
- Communication with Employees
- Employees often misunderstand bonus taxation, assuming their bonus is “overtaxed.” Explaining that withholding is an estimate, not the final tax liability, helps avoid confusion.
- Employees often misunderstand bonus taxation, assuming their bonus is “overtaxed.” Explaining that withholding is an estimate, not the final tax liability, helps avoid confusion.
Best Practices for Employers and Payroll Professionals
- Plan Timing Carefully: Bonuses paid in the same paycheck as regular wages may create higher withholding under the aggregate method. If you want more predictable results, issue bonuses in a separate check using the flat rate.
- Document Policies: Clearly outline how bonuses are taxed and communicated to employees. Consistency reduces confusion and complaints.
- Use Payroll Software: Modern payroll systems can automatically apply the correct withholding rules for federal and California taxes. Regular updates are key to staying compliant.
- Stay Current on Rates: Withholding percentages can change. Always verify the latest IRS and California FTB rates before processing bonuses.
- Consult Experts When Needed: For complex cases, like equity compensation, executive bonuses, or multi-state employees, working with a tax advisor or attending compliance training is wise.
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Conclusion
Bonus taxation in California may look complicated at first, but once you break it down, the rules are clear. Bonuses are supplemental wages, taxed under both federal and state guidelines. At the federal level, employers can use either the flat percentage or aggregate method. At the state level, California requires a flat withholding of 10.23% (or 13.3% for stock options), though the aggregate method is also allowed.
For payroll professionals and employers, the key is to apply the correct method, stay consistent, report accurately, and communicate openly with employees. Done right, bonuses remain what they should be: a tool to motivate, retain, and reward employees, not a source of confusion or compliance headaches.By staying informed and proactive, you ensure your payroll processes not only meet legal requirements but also support employee trust and satisfaction. To stay updated on such workforce strategies, HR professionals can explore Compliance Prime’s expert human resources webinars for practical insights and guidance.
