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. For more information about setting up Canadian payroll, check out Knit's Ultimate Payroll Set-up Guide.
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’ 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:
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.
Here’s an in depth example of the federal tax calculations to make things extra simple:
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).