Bonuses are taxed as income, and the IRS will work hard to identify the amount you received. There are several tax deductions that you can claim in order to reduce your tax liabilities.
Since bonuses are taxed as income, they must be included in gross income before any allowable deductions and credits are calculated. The threshold amount or the sum of all these added items is called adjusted gross income (AGI). Once the AGI is calculated, offsets such as foreign-earned wages may be applied to the AGI prior to taxable wages, referred to by the IRS as wage limitation on itemized deduction. This article will go through the IRS process for determining bonus income and some deductions you can take to lower your tax liability.
1. Take Advantage of Tax Credits
Tax credits are a great way to lower your tax liability. They can be applied to help offset the amount you owe on your taxes, or they may help pay for certain expenses. Some of these credits are refundable and may allow you to receive more money than you owe in taxes. In order to access more tax credits, it is a good idea to speak with a tax advisor if you are unfamiliar with these terms.
2. Foreign Earned Wages
If you work overseas, consider requesting an adjustment in wage limitations on itemized deductions and standard deductions (SDP). Itemized deductions are generally for out-of-pocket expenses and involve the costs of running a business. The SDP allows you to deduct an amount from the tax that you owe; the amount is calculated using a formula based on your AGI. These two deductions will offset each other, and when you finally calculate your tax liability, the IRS will apply either the larger one or, the smaller of the two limitations.
If you have foreign-earned wages, it is essential to note that before these limitations can offset any bonus income, your bonus must first be included as wages and reported on your W-2 form.
3. Harvest Investment Losses
Take advantage of tax losses if you have a net operating loss. If you can generate a loss, you can offset taxes on other income. Keep in mind that the IRS has a carry-forward rule for passive losses, which means you can carry these losses forward to be used in future tax years. You will need to disclose the amount of your anticipated passive income for any given year, or else the IRS may disallow your deductions, credits, and exemptions from being applied; this will happen regardless if it is discovered when you file or during an audit.
The smaller the net operating loss, the better, as it is easier to offset it with income after all deductions and credits have been applied.
Bonuses are great — few would argue otherwise — but one must be aware of the tax consequences that result from receiving one. The IRS wants to ensure that you pay your fair share of taxes, and they will work hard to determine the amount of taxable income you receive.
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