Taxes Higher on Vacation Pay

[jyeh74]

Usually taxes on salary is about 25% per paycheck. But combined with vacation payout, taxes increased to 35%. Why is vacation payout considerably higher than normal salary?

[llworking]

Usually taxes on salary is about 25% per paycheck. But combined with vacation payout, taxes increased to 35%. Why is vacation payout considerably higher than normal salary?

The amount of taxes withheld is based on the amount of income you have in a given paycheck. Our system of federal withholding is a stair step system where higher income has higher withholding. You aren't being taxed a higher amount on vacation pay, you are being taxed a higher amount because the vacation pay raises your overall income enough that some of it is in a higher tax bracket, so more is withheld.

In the end however, when you file your tax return your taxes will be calculated based on your overall income for the year. Your withholding will be applied towards your tax. Odds are that a single paycheck with excess withholding will just mean that you end up with a refund.

[Harold99]

The amount of taxes withheld is based on the amount of income you have in a given paycheck. Our system of federal withholding is a stair step system where higher income has higher withholding. You aren't being taxed a higher amount on vacation pay, you are being taxed a higher amount because the vacation pay raises your overall income enough that some of it is in a higher tax bracket, so more is withheld.

In the end however, when you file your tax return your taxes will be calculated based on your overall income for the year. Your withholding will be applied towards your tax. Odds are that a single paycheck with excess withholding will just mean that you end up with a refund.

Are you saying that a person who earns say $200,000 a year is in multiple tax brackets?

I agree with most of what you said but I'd say that when a vacation check doubles your income from $2,000/wk to $4,000 that week, they tax you that week as though you make $208,000/yr. But you don't/won't.

It is my opinion that when you are pushed into say a 35% tax bracket, your whole paycheck is taxed at that new higher rate. Do you agree?

[llworking]

Are you saying that a person who earns say $200,000 a year is in multiple tax brackets?

I agree with most of what you said but I'd say that when a vacation check doubles your income from $2,000/wk to $4,000 that week, they tax you that week as though you make $208,000/yr. But you don't/won't.

It is my opinion that when you are pushed into say a 35% tax bracket, your whole paycheck is taxed at that new higher rate. Do you agree?

No, that is not correct. Again, our federal tax system is a stair step system. The first bit of income is not taxed at all (the amount below your standard deduction), the next bit is taxed at 10%, the next a 12%, the next at 22%, the next at 24% and so on. So yes, a person making 200k a year has income taxed in multiple tax brackets. When someone talks about someone's marginal tax bracket they are talking about the highest bracket that someone's particular income will hit.

Withholding works the same way, although it's pro-rated based on how often you are paid and how much is in each paycheck.

I agree that if a weekly paycheck is $4000 one week the withholding system is going to treat them as if they make $208,000 a year even if they don't make nearly that much, but withholding is still going to be calculated based on the stair step system.

[Harold99]

No, that is not correct. Again, our federal tax system is a stair step system. The first bit of income is not taxed at all (the amount below your standard deduction), the next bit is taxed at 10%, the next a 12%, the next at 22%, the next at 24% and so on. So yes, a person making 200k a year has income taxed in multiple tax brackets. When someone talks about someone's marginal tax bracket they are talking about the highest bracket that someone's particular income will hit.

Withholding works the same way, although it's pro-rated based on how often you are paid and how much is in each paycheck.

I agree that if a weekly paycheck is $4000 one week the withholding system is going to treat them as if they make $208,000 a year even if they don't make nearly that much, but withholding is still going to be calculated based on the stair step system.

If you are speaking to one person about his one income, as we are doing here, it is not a stairstep system. If a person makes $1,000/wk, he is taxed at a rate of $52K every day, every week, every month and at the end of the year. No "stairstep"at all.

[pg1067]

You provided no factual information (e.g., amount of regular pay, amount of vacation pay, frequency of pay, and relevant state), so all anyone can provide is general information.

By way of example, let's assume you're paid a salary of $1,000 per week. I'll also assume, for the sake of simplicity, that you're in a state that doesn't have income tax, so I'll assume the only deductions are social security, medicare and federal income tax.

Social security and medicare are deducted on a flat rate basis. Social security is 6.2%, and medicare is 1.45%, so you're going to have $76.50 deducted from every $1,000 paycheck for those things.

As "llworking" pointed out, federal income tax liability is calculated on a stair step basis. If your annual, taxable income (which will typically be less than your gross income) is $52,000, for 2020, you are in the 22% tax bracket, but you won't pay 22% in federal income tax because of the stair step system. Your tax liability will be calculated as follows:

10% x $9,875 = $987.50
12% x ($40,125 - $9,875) = $3,630.00
22% x ($52,000 - $40,125) = $2,612.50

Total tax liability = $7,230.00

When your payroll deductions are calculated, it will be assumed that you'll earn the same amount every pay period. Your federal tax liability per paycheck will be $7,230/52 = $139.04.

Therefore, your payroll deductions should be $139.04 + $76.50 = $215.54, so you'll take home $784.46.

Now, let's say you get a $1,000 bonus, and your employer includes that as part of your weekly pay. Now, your payroll deductions are going to be calculated on the assumption that you'll earn $104,000, which is in the 24% tax bracket. The federal tax liability will be $987.50 + $3,630.00 + 22% of the amount between $85,525 and $40,125 ($9,988.00) + 24% of the amount over $85,525 (in this case, $18,475 x 24% = $4,434). The total would be $19,039.50 or $366.14 per week, which is more than twice your normal withholding.

Thus, for your $2,000 paycheck ($1k weekly salary plus $1k bonus), you'll have $366.14 deducted for federal income tax and $153.00 for social security and medicare, so you'll net $1,480.86.

Comparing the overall percentage of deductions, the deductions from your normal check will be 10.78%, but the deductions from your $2k check will be 25.96%.

The foregoing is overly simplistic for a couple reasons and is based on some assumptions that might or might not be true on an individual basis, but it should illustrate why you might be seeing what you're seeing.

[llworking]

If you are speaking to one person about his one income, as we are doing here, it is not a stairstep system. If a person makes $1,000/wk, he is taxed at a rate of $52K every day, every week, every month and at the end of the year. No "stairstep"at all.

Yes, it is a stair step system. However, I am perhaps explaining it poorly. Yes, if he is making $1000 a week he will be taxed as if he makes $52,000 a year. It is how the withholding and tax are calculated for that $52,000 that is the "stair step". I am giving these figures as an example only, because I don't have the tax rate schedules in front of me: So, of that $1000 paycheck the first $230 will not have withholding calculated on it. The next $230 of that $1000 paycheck will have withholding calculated as $23.00 (10%). The next $300 will have withholding calculated as $36.00 (12%) and the remainder, $240 will have withholding calculated as $52.80 (22%) for total withholding of $111.80.

If another $1000 gets added on top of that then part of that would get calculated in the 22% bracket and some in the 24% bracket, which is why withholding ends up being so much more.