Bonus payouts: everyone loves them. What everyone doesn’t love is having to pay taxes on their hard-earned bonuses. Luckily, not everyone has to.

 

Disclaimer: the information in this blog post is written for Canadian businesses only

Typically, employees must pay out CPP (Canada Pension Plan) and EI (Employment Insurance) from their bonus payments. There is, however, an exception. If an employee has contributed the maximum yearly amounts for CPP and EI, they are exempt from further deductions.

Unless the bonus is being allocated to an RRSP, income tax will always be deducted from bonus payments. If putting the money into an RRSP, the net amount (after CPP and EI deductions) can be deposited so long as said employee has sufficient room left in their RRSP’s yearly contribution limit.

The Periodic Method vs. The Bonus Method

The ‘periodic method’ is the CRA’s method for calculating income tax source deductions. This method is the most similar to the bonus method.

The Period Method calculates the federal and provincial/territorial tax deductions on total salary, wages, taxable benefits, pension income, commissions, and other period payments. This method is the default when no other methods apply. It’s used for earnings that are paid out on a regular pay period basis.

Here’s the fun part: The Bonus Method is pretty much the same, only it calculates the tax twice. The first time with the bonus, and the second without. The Bonus Method is also used for exception earnings, which are paid out on an irregular basis.

Exception Earnings can include things like:

  • Bonuses
  • Accrued vacation pay paid out without taking time
  • Sales commissions
  • Banked overtime
  • Taxable benefit from stock "security" options

The Period Method and The Bonus Method share the same logical structure. All earnings or deductions are converted into annual taxable income. The annual tax owing on this income is calculated. This annual tax is converted to the amount owing for the pay period.

The two methods also share similar logic for calculating annual tax once the annual taxable income has been determined.

Payroll Bonus Tax Calculation Examples

Here’s an in depth example of the federal tax calculations to make things extra simple:

  • Rate of Pay: Employee is paid $1,600 per pay period [enter employee pay]
  • Bonus Amount: Employee is receiving a single bonus of $5,000 [enter all employee bonuses that will be received in the tax year]
  • Pay Schedule: Employee is paid bi-weekly [enter payroll frequency]
  • Claim Code: Federal tax claim code is 1 (basic) [enter appropriate tax code]
  • Withholding Status: CPP and EI Exempt [enter any withholdings]
  • Employment Credit: Canada Employment Credit does not apply [enter any applicable credits]
  • Annual Tax Owing Rate: Ontario [select appropriate province/territory]
  • Tax Year: 2018 [enter correct year]

The Periodic Method

Federal Income Tax Calculation Bonus
Calculate pay period earnings (salary + bonus) by the number of periods per year (26 for bi-weekly payroll). $171,600
Calculate annual tax owing, at 29%, minus $10,863 (refer to section A on CRA chart T4032) $38,901
Divide annual tax by the number of periods per year (26).  $1,496.19

 

The Bonus Method

Federal Income Tax Calculation Period with Bonus Period with Bonus
Multiply pay period earnings by the number of periods per year ($1,600 X 26). $41,600 $41,600 
Add the current bonus. $5,000  
Total annual taxable income $46,600 $41,600 
Calculate the annual tax owing, at 22%, minus $3,129 (refer to section A on CRA chart T4032). $7,123   $6,023
The tax owing is the difference between the 1st and 2nd results.  $1,100.00  $231.65

 

When using The Periodic Method, the employee would owe $1,496.19 in taxes. When using The Bonus Method, the tax owed would be $1,331.65 because the employee is taxed $231.65 on their salary as well as $1,100.00 on their bonus.

The Bonus Method actually lowered the federal tax on the bonus by $164.54.

If you’re curious to try these calculations out for yourself, check out the CRA’s Payroll Deductions Online Calculator (PDOC).