Bonus season is upon us, and while you might initially cheer at the thought of extra cash in your bank account, it’s important to realize the tax implications before you start spending. Getting taxed at the supplemental income rate could leave you with a lot less cash than you expected.
Using charitable giving as part of your tax strategy can minimize your tax bill while also making a difference in the world. A donor-advised fund can lower your taxable income while helping charities you care about. Plus, you can invest the money in your chosen portfolio until you’re ready to make a donation.
A Big Bonus Can Mean Big Taxes
For most people, bonuses are not taxed as regular income. Instead, they’re typically taxed as supplemental income. For federal taxes, that means you’ll end up paying a flat 22% tax rate on bonuses that are under $1 million. Bonuses that exceed the $1 million thresholds are bumped up to a 37% tax rate. Each state also has its own tax treatment of bonuses to include in your calculations. In California, for instance, employees pay an additional 10.23% on bonuses, which comes to a combined 32.23% to 47.23% tax rate for federal and state (depending on the size of the bonus).
Employers typically withhold both federal and state taxes before you receive your bonus check. That means you’re likely to notice a much lower dollar amount than you might have anticipated. For people who make plans for or even spend their bonuses before they receive them, this can be a very unwelcome surprise.
The exception to the supplemental income rule is income and commission earned by self-employed individuals, such as sole proprietors and real estate agents. These earnings are subject to a different set of tax rules. This typically includes both income tax (at whatever applicable tax bracket) and self-employment tax, which covers things like Social Security and Medicare contributions. The current federal self-employment tax rate is 15.3%. Any large commission or consulting fee you receive will be subject both to your income tax rate, plus that extra 15.3%.
No matter how you receive bonus income, it’s clear that the tax impact can be significant. But understanding how your bonus is taxed is the first step in creating a plan to minimize that final bill.
How a Charitable Donation Can Help Lower Your Tax Bill
An estimated 73% of Americans reported donating to charity in 2020. While that number may seem high, it’s actually a new low, dropping even lower than 2009 at the onset of the Great Recession. While the COVID-19 pandemic likely shook the financial stability of many households, recent tax changes have also made it more difficult to use charitable giving to offset federal taxes.
A larger standard deduction for both individual tax filers and those married and filing jointly makes it less common for taxpayers to itemize their deductions. That means you may need to think outside the box in order to deduct your charitable contributions.
Here’s a look at the standard deductions for 2022:
- Single or married filing separately: $12,950
- Married filing jointly or surviving spouses: $25,900
- Head of household: $19,400
Unless you’re able to itemize tax deductions beyond the standard deduction for your filing status, you can’t deduct nonprofit donations from your taxable income.
Even so, it’s estimated that 30% of taxpayers itemize their deductions. And for those who do, you can deduct charitable contributions up to 60% of your adjusted gross income. But if you are married with a mortgage and live in a state with a high-income tax, you may very well be able to itemize your deductions.
When to Use a Donor-Advised Fund for Giving
Using a donor-advised fund (or DAF) lets you make a tax-deductible contribution without having to figure out who to give the money to right away. Instead, the money grows in an investment account so you can make even more of an impact as you determine which charities to support.
With Daffy, you can select from a variety of investment options, including stocks, bonds, and cryptocurrency. When you’re ready to give to your favorite charity, simply donate directly through the app. That makes it easier to track your deductions during tax season since all of your giving history is in one safe place.
Let’s Look at a Sample Scenario
Let’s say Leah is a senior manager at a major tech company. She earns $200,000 a year and in January, she received a $20,000 bonus, which qualifies for the 22% federal tax rate. That lowers her take-home bonus to just $15,600 (not including state taxes) — $4,400 is withheld from her employer for federal taxes.
But giving back is also important to Leah, and she tries to donate to her favorite nonprofit organizations when she can. Leah downloads the Daffy app and makes a $10,000 contribution with some of the funds from her bonus. But she doesn't have to give all of the money at once. Leah can give some to the causes she already supports like the local food bank and her church. The rest of her contributions will be invested tax-free and she can make more donation recommendations whenever she’s ready.
When tax season rolls around in the following year for her 2022 income, Leah and her partner Jamie (who also earns $200,000 per year), have a total household income of $400,000. Instead of taking the joint filing standard deduction of $25,900, they initially itemize the following deductions:
- $25,000 in mortgage interest
- $11,801 in property tax
But because Leah donated $10,000 in her Daffy account, she can deduct that extra amount, for a total itemized deduction of $46,801. In total, Leah and Jamie are able to nearly double their deduction from the standardized limit through both charitable giving and other eligible expenses.
Give More & Save on Taxes with Daffy
Charitable giving helps you make a positive difference where it matters most to you. It can also lessen the blow of the amount of taxes taken out of your bonus by reducing your taxable income. Using a donor-advised fund like Daffy simplifies the process by letting you take advantage of that tax deduction without having to make multiple giving decisions at once. Plus, your entire giving history is in one secure spot when tax season rolls around.
Make giving (and saving on taxes) a habit by downloading the Daffy app.
Please note that the information contained in this email is for educational purposes only and should not be considered tax advice. To assess your specific tax situation, we always recommend that members consult with a certified tax professional.