How Does the Bonus Tax Method Work in Payroll?

December 7, 2015 Darlene Huntley

Bonus Tax Method Canada

Updated December 2016

This blog post is written for Canadian businesses. Click here for How to Handle Taxes on Bonus Wages for US based companies.

As exciting as bonus payouts can be for your employees, for most of them, it is a bittersweet payment because of the amount that is paid out in taxes. 

While those concerns are valid, they are slightly exaggerated.

Canada Pension (CPP) and Employment Insurance (EI) are mandatory deductions on a bonus payment with one exception – when an employee has contributed the maximum yearly amounts for CPP and/or EI no further deductions will occur.

Related: What You Need to Know About Payroll Remittance Schedules 

Income tax, on the other hand, is required unless the bonus is being allocated to an RRSP.  

When this option is chosen, the net amount (after CPP and EI are deducted) can be put into the employee’s RRSP - providing they have room in their yearly contribution limit.

So, how does the bonus tax method work in payroll?

The best way to answer this question is by contrasting it with the normal rules for calculating CRA income tax source deductions, termed the periodic method. 

There are other CRA tax methods – the lump-sum and TD1X methods – but the periodic method is the one closest to the bonus method itself.

For the discussion in this post, we will focus on comparing and contrasting the periodic and bonus methods for calculating income tax on bonuses. 

The Periodic Method vs. The Bonus Method

The periodic method determines the federal and provincial or territorial tax deductions on total salary, wages, taxable benefits, pension income, commissions, and other periodic payments. The periodic method is the default when no other method applies and is used for earnings paid on a regular pay period basis. 

The bonus method uses the periodic method,  only it calculates the tax twice – once with the bonus and once without the bonus. The bonus method may also be used for exception earnings, meaning those paid on an irregular basis, including:

  • Bonuses
  • Sales commissions paid on an irregular basis
  • The cash-out of banked overtime, without taking time in lieu
  • Accrued vacation pay, paid without taking time 
  • The taxable benefit from stock (“security”) options

For example, when employees work overtime and are paid for that overtime in the same pay period, the periodic method applies. The same is true when employees are subsequently given time in lieu. The bonus method only applies to overtime that’s banked and then subsequently paid out, only as cash, such as on termination.

There are two things that the bonus and periodic methods share in common.

First, they share the same overall logical structure:

  1. The earnings or deductions concerned are converted to annual taxable income.
  2. The annual tax owing on this income is calculated. 
  3. This annual tax is converted to the amount owing for the pay period.

Stay on track for 2017 with a downloadable Payroll Calendar. 

Second, the bonus and periodic methods, with minor differences, share the same logic for calculating annual tax, once annual taxable income has been determined.

**The minor difference applies to the calculation of personal income credits for CPP and EI source deduction amounts, but we won’t go into that level of detail here.**

To keep it simple, we’ll limit our example to showing just the federal tax portion of the bonus calculation.

Here are the details we need to perform the payroll calculations shown in this post:

(The data we're using is for this one specific example. You would use similar variables in your own calculations, accommodating for salary or hourly, bonus amount and frequency, pay frequency, tax claim codes, CPP and EI exemption, etc. relevant to your employees and your company.)  

  • Rate of Pay: Employee receives a $1,600 salary every pay.

  • Bonus Amount: Employee is receiving a (one-time) bonus of $5,000 on this pay. (If the employee had a previous bonus within the year or will receive others, these will also need to be taken into account.)

  • Pay Schedule: Employee is paid bi-weekly. (You would need to enter what's appropriate for your company, monthly, weekly, bi-weekly, semi-monthly.) 

  • Claim Code: Federal tax claim codes is 1 (basic).  

  • Withholding Status: Employee is CPP and EI exempt. 

  • Employment Credit: The Canada Employment Credit does not apply. 

  • Annual Tax Owing Rate: The Annual Owing Tax Rate in this example is for Ontario. (In doing your own calculations, you'd have to select the appropriate province.) 

  • Tax Year: Tax year is 2015 for this example. (For accuracy, use the appropriate tables/rates for your tax year.)

 Payroll Bonus Tax Calculation Examples

Example One – Periodic Method

Step

Federal Income Tax Calculation

Bonus

1

Multiply pay period earnings (salary + bonus) times the number of periods per year, 26.

$171,600

2

Calculate the annual tax owing, at 29%, less $10,863 (refer to section A on CRA chart T4032).

$38,901

3

Divide the annual tax by the same number of periods per year, 26.

$1,496.19

 
   

Example Two – Bonus Method

Step

Federal Income Tax Calculation

Period with Bonus

Periodic without Bonus

1

Multiply pay period earnings times the number of periods per year, $1,600 times 26.

$41,600

$41,600

Add the current bonus.

$5,000

 

Total annual taxable income

$46,600

$41,600

2

Calculate the annual tax owing, at 22%, less $3,129 (refer to section A on CRA chart T4032).

$7,123

$6,023

3

The tax owing is the difference between the 1st and 2nd results.

$1,100.00

 $231.65

Using the periodic method, the total amount the employee would pay in taxes would be $1,496.19, and in the bonus method the tax paid would be $1,331.65 ($231.65 on their salary plus $1,100.00 on the bonus).  

So, by using the bonus method it lowered the federal tax on the bonus by $164.54.

While Wagepoint uses the periodic method for calculating taxes on bonuses, it's an easy workaround to use the bonus method in order to reduce the tax contributions for you and your employees. 

And, that’s bonus taxation in a nutshell. 

Related: 8 Steps to Ensure an Accurate & Compliant Year-End Payroll Filing

This post was produced in collaboration with Alan McEwen, a Vancouver Island-based HRIS/Payroll consultant and freelance writer with over 20 years’ experience in all aspects of the industry. 

About the Author

Darlene Huntley

A consummate multi-tasker, don’t be surprised if you find Darlene doing her best Juice Newton impression to ‘Queen of Hearts’, playing fetch with her little doggie Niko - all while working to provide world-class service to our customers everyday. She makes everything seem effortless! You need something done quickly and right the first time? She’s the one you call.

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