2016-12-11 00:00:00 Taxes English Learn the differences between the periodic method and the bonus method. Learn how these methods affect employee take-home pay. https://d1bkf7psx818ah.cloudfront.net/wp-content/uploads/2017/03/08214634/Restaurant-bar-employee-calculating-taxes-at-register-tablet-with-customer-standing-and-diners-at-table.jpg How the Bonus Method of Calculating Taxes Can Increase Employee Take-Home Pay

How the Bonus Method of Calculating Taxes Can Increase Employee Take-Home Pay

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Typically, when you pay an employee, you withhold taxes from their cheque, as if they earn that same amount all year long. This is called the periodic method, and it is effective in most cases. However, if your employee has an unusually large paycheque – due to a bonus or another lump-sum payment – this method may end up withholding more income tax than necessary. To avoid this situation, consider using the bonus method rather than the periodic method.

Periodic Method

To illustrate how you apply the periodic method, imagine your employee’s biweekly paycheque is $1,000 plus a $5,000 bonus. In this case, you multiply $6,000 times the number of pay periods (26) to get $156,000.

To determine how much tax to withhold, you should look at chart 1 of T4032 (Payroll Deductions Table). This chart is updated annually to reflect changes in federal tax rates – as of 2016, this salary falls into the 29% federal tax bracket.

To continue, multiply $156,000 by 0.29. Then, subtract $11,683 – the CRA provides this number to account for the income that doesn’t fall into the 29% tax bracket. The result of these calculations is $33,557. When you divide this number by 26 (the number of pay periods), the result of $1,290.65 is the amount you should withhold for federal income tax. However, as your employee’s paycheques are not usually this big, this is likely to be far more income tax than your employee usually owes.

Bonus Method

To boost employee take-home pay, consider using the bonus method to calculate how much income tax to withhold. In this method, you calculate projected annual income tax based on your employee’s annual salary both with and without the bonus. First, multiply your employee’s usual pay ($1,000) with the number of pay periods (26). The result is $26,000, and based on the CRA’s chart, you should withhold 15% as income tax. That results in annual income tax of $3,900 and biweekly income tax of $150.

When you add the $5,000 bonus to the employee’s annual salary, the result is $31,000, which also falls into the 15% tax bracket and results in annual income tax of $4,650. The difference between these two annual tax payments reflects how much income tax your employee should pay on the bonus. When you subtract $3,900 from $4,650, the result is $750. You should also withhold the usual $150 to account for income tax on your employee’s regular earnings.

Periodic Versus Bonus Methods

To continue with the above example, if you use the periodic method, you withhold $1,290.65 from your employee’s cheque – but if you use the bonus method, you only withhold $900. This puts an extra $390.65 in your employee’s hands up front.

This example only takes federal income tax into account. To address Canada Pension Plan contributions, Employment Insurance premiums, or provincial income tax, you need to do extra calculations or use quality payroll software.

References & Resources

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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