Many employees receive an annual bonus payment as part of their remuneration package, and for most, this bonus is paid in December of each year. So, for many employees, this time of the year should be a happy time when they see the word “Bonus” appearing on their payslip.
However, employees are often disappointed when they look further down the payslip and discover what they will actually take home. Once the taxman has taken his share there isn’t that much left to enjoy, spend and spread around.
The question is always the same. Why did I clear so much less than I thought?
We receive many queries from employees about what percentage tax they ended up paying on their bonus, or prior to receiving their December payslip, wanting to know how much they will clear. When they see the result, the immediate question is why they are paying so much more tax on their bonus than on their normal pay.
It’s important to start off by clarifying that there is no specific or different rate of tax applied to a bonus payment (or any other once-off payment, such as a commission payment), it simply has to do with the fact that we use a progressive tax system in South Africa, meaning that the more one earns the higher percentage tax one pays on those earnings.
The general rule is that employees are taxed at the rate of the marginal tax bracket in which they fall. Let’s explain:
- if their salary is between R 1 and R 216 200, they are in the 18% tax bracket and therefore their bonus will be taxed at 18%.
- similarly, if they are earning R 1 656 601 and above, they are in the 45% tax bracket and as such their bonus would be taxed at 45%.
- this holds true only if their bonus does not push them into the next tax bracket, which would naturally cause the total bonus or a portion of the bonus to be taxed at a higher rate.
Your employer should withhold the tax payable before the amount is paid to you. However, some employers may tax you more than you should be taxed each month during the year to ensure you do not pay substantial tax on your bonus when you receive it. In other words, you pay too much tax during the year so that you can get your full bonus at the end of the year. Employers in this case help you prepare for the tax you pay on your bonus. This is often referred to Voluntary Additional Tax.
So, how does a bonus get taxed?
The bonus amount becomes part of an individual’s total taxable income for the year – i.e. it gets added to the annual earnings – which in many instances can push those annual earnings into a higher tax bracket. The bottom line – as earnings move up the tax table and into the next tax bracket, so the percentage tax due on those earnings increases as well. Sad but true!!
Another important point to note is that the amount of tax withheld in the month in which the bonus is paid depends on which method the company uses to calculate tax. Electronic payroll systems have a few ways in which the company can set up the rules regarding how the tax calculation must be done, so companies generally try and use the method that has the least impact on an employee from a tax perspective, in the month that the bonus is paid.
Here is an example:
Example 1 (basic tax calculation – excluding bonus)
The employee earns R 30 000 as a basic salary (monthly) and in December the employee gets a performance bonus of R 15 000.
The tax calculation on the basic salary of R 30 000 per month would be:
The next step is to do the same tax calculation but this time, include the R 15 000.00 bonus payment. There are two ways to do the tax calculation:
1 – The Annualisation of Income method
Using this method, the total income for the month is annualised. Here the basic salary (i.e. the R 30 000) and the bonus amount (i.e. R 15 000) are combined and then multiplied by 12, giving R 540 000.
The tax calculation on a basic salary of R 30 000 plus a bonus of R 15 000 (i.e. R 45 000) would be:
The downfall of this method is that the calculation for that month assumes that the employee will be receiving the higher income for every month of the tax year, which is obviously not the case. The result is that the tax paid on the bonus in that month is actually based on an “inflated” assumption of the annual earnings, and as such the tax on the bonus amount will be high.
Fortunately, in the following month, the tax calculation will revert back (i.e. will be based on the R 30 000.00 or R 360 000.00 p/a) because the tax calculation is done all over again, and naturally in the following month will not include the R 15 000.00 bonus. Some systems will take into consideration the overpayment in the previous month and “give back/smooth out” that overpayment over the remaining months in the tax year.
So, by using this method of tax calculation, the employee, in most instances, will have been overtaxed and will therefore be out of pocket – but the good news is that when it comes to tax filing season and the employee completes their annual tax return, SARS will refund the overpaid amount.
2 – The Balance of Remuneration method
The other method used, which is a little more accurate, is the balance of remuneration method. It provides a more accurate projection of income for the year and therefore produces a more precise tax calculation.
Similar to the method previously described one first calculates the tax for the year when no bonus is involved, and then one determines the tax for the year with the bonus amount added. The difference between the two becomes the tax payable on the bonus component of income and must be added to the ‘normal’ tax amount.
Here’s how it is calculated:
By comparing the two methods of calculating the tax on a bonus it is clear that there is a huge difference depending on which method is used – which gets much worse with higher earnings and larger bonus payments. The one method provides a much more accurate amount based upon realistic projected earnings whilst the other is a lot more costly for the employee, bearing in mind that the excess will be refunded by SARS. But then who wants to be out of pocket if they don’t have to be?
Final comment – two things to consider:
1 – if the tax on the bonus does not seem right (i.e. it’s too high) then:
- check that the bonus has not been added to the monthly salary and the result then annualized, as this will inflate the projected earnings for the year, resulting in a higher tax liability. The salary should be annualized first and then only should the bonus amount for that month be added to derive the more accurate annual earnings.
- Check that the bonus has not pushed the employee into a higher tax bracket as this will definitely cause the tax on the bonus to be higher.
2 – paying less tax on the bonus:
- Many employers (and SARS) allow for a higher tax deduction to be made on a monthly basis during the tax year. This is known as Additional Voluntary Tax. When SARS sees this higher than what is expected tax deduction (i.e. in the mid-year submission) they look at another indicator on the employee’s IRP5 which tells them that the over deduction is voluntary.
- Either a fixed Rand value or a percentage can be used, depending on what the employer’s payroll system allows for, to provide for the tax that will be applicable when the bonus is paid, on a monthly basis. The anticipated tax on the bonus is then spread across the months leading up to the actual payment of the bonus – making the tax due on the bonus a lot less painful to deal with, and of course, more take-home pay for the employee.
- A general rule of thumb, particularly in the case of high earners, should be to seek advice on how all this can be done from a professional. Getting it wrong can put the employer on the wrong side of SARS, a place no one wants to be these days as non-compliance can be very expensive.