2016-12-11 00:00:00TaxesEnglishLearn the differences between the periodic method and the bonus method. Learn how these methods affect employee take-home pay.https://quickbooks.intuit.com/ca/resources/ca_qrc/uploads/2017/03/Restaurant-bar-employee-calculating-taxes-at-register-tablet-with-customer-standing-and-diners-at-table.jpghttps://quickbooks.intuit.com/ca/resources/taxes/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

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

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Typically, when you pay employees, you withhold taxes from their paycheques. This allows you to keep track of payroll easily, because everyone makes a set amount every pay period throughout the year. This process of tracking a worker’s pay, referred to as the periodic method, is often effective with regards to withholding income taxes.

However, the periodic method may actually create a situation where you withhold more income tax than necessary if your employee has an unusually large paycheque. Having a larger-than-normal cheque can result when you add a bonus or other lump-sum payment onto your employee’s weekly salary. To avoid withholding more taxes on an employee’s paycheque, consider using the bonus method rather than the periodic method to pay an employee.

How the Periodic Method Works

With the period method, you first multiply the employee’s total paycheque amount by the number of pay periods in one year. For example, imagine your employee’s paycheque comes to $1,000 and they receive a $5,000 bonus. You pay your employees bi-weekly, or 26 times per year. The calculation, $6,000 x 26, results in $156,000.

To determine how much tax to withhold for your employee, you refer to chart 1 of T4032 (Payroll Deductions Table). The Canada Revenue Agency (CRA) updates this chart annually to reflect changes in federal tax rates. You can also calculate the withholding using the Payroll Deductions Online Calculator. As of 2018, the salary of $156,000 per year falls into the 29% federal tax bracket for the upper $11,511. Lower amounts have smaller percentages taken out.

The result of these calculations comes to $33,557 in total tax that someone with that salary should pay. When you divide this number by 26, or the number of pay periods, the result is $1,290.65 to withhold from the employee’s paycheque for federal income tax. However, your employee’s paycheque is inflated as the result of a bonus payment. It is not usually this large. Therefore, you may accidentally withhold more taxes than necessary. This occurs only on the one paycheque where you offer the bonus as opposed to withholding this tax amount on every cheque.

How the Bonus Method Works

To boost employees’ take-home pay, consider using the bonus method to calculate how much income tax to withhold. 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 by the number of pay periods. Continuing with the above example, $1,000 x 26 results in $26,000. Based on the CRA, you should withhold 15% as income tax. That results in annual income tax of $3,900 and bi-weekly income tax withholding of $150.

When you add the $5,000 bonus to the employee’s annual salary, the result is $31,000. That 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

If you use the periodic method, you withhold $1,290.65 from your employee’s paycheque. Using the bonus method, you only withhold $900, or $750 plus $150. 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 payroll software such as QuickBooks Online. Robust payroll software makes tax time easier. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.

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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