We are very close to Christmas and being the time for giving, some employers might be thinking of providing an annual bonus to employees. When employees are paid bonuses, it is assessable income to them and processed as such in payroll:
• Deduct PAYG from the amount using a marginal rates calculation
• Report it as a gross amount via STP
• Included as part of ordinary time earnings (OTE) for super guarantee purposes
How is this treated in payroll?
If a bonus only relates to work performed ‘purely’ during a single pay period (for example, a weekly, fortnightly or a monthly bonus) the amount is added to all their other earnings for the current period, and tax is calculated using the relevant PAYG withholding tax table. Indeed, this would increase the tax in that one pay period.
If a bonus does not relate to a single period, a way to tax the bonus is to average it. This is known as a “marginal rates” calculation.
This common practice is about spreading equal portions of the bonus on top of the employee’s regular pay and working out the tax difference between the “Average Pay” and the “Average Pay + Average Bonus”.
The difference in tax is summed up by the same number of periods it was divided by to find the full amount of PAYG payable on the bonus.
The ATO has provided two acceptable methods to apply. Known as Method A or Method B.
To illustrate the concept, below is method A. Method A is a simpler calculation and the most commonly used method.
Dawson is a weekly paid employee earning $900 per week normal pay.
He is going to receive an annual Christmas bonus of $9,000 bonus (average of $173.077 per week). Because this is an annual bonus his payroll department will average the tax over the financial year. Dawson is claiming the Tax-free threshold and does not have HELP.
Marginal Calculation for Dawson Gross Pay Weekly PAYG
Average weekly pay $900 $148
Average Bonus (9000/52 week = 173.077) $173.08
Average Pay + Average Bonus $1,073.08 $208
Difference in tax $60
Total Tax Payable on the bonus is $60 x 52 week $3,120
Bonus notes on bonuses:
*Please note that you ignore the cents when looking up the tax tables.
*If the total PAYG calculated at marginal rates is greater than 47%, then cap the PAYG at 47%.
Here are some common questions that you may encounter whilst processing bonuses.
Can an employee salary sacrifice their upcoming bonus?
An employee would need to set up a salary sacrifice arrangement before they start the work. If their arrangement is not put into place until after they have performed the work, it may be ineffective.
An employee cannot salary sacrifice a bonus after they have already passed the qualifying period to receive that bonus. They must have a written salary sacrifice arrangement in place prior to earning the entitlement to the bonus.
As an example, if a Christmas annual bonus is to be paid in December 2020 the salary sacrifice arrangement would need to be in place before 1 January 2020.
More information can be found in the following link:
https://www.ato.gov.au/Business/Super-for-employers/In-detail/Salary-sacrifice/Salary-sacrificing-super—information-for-employers/?page=2
An employee has a tax variation arrangement with the ATO, can we apply this to the bonus?
Unless the PAYG variation specifically states the word “bonus” on it, then the bonus is subject to normal tax rules and is taxed at marginal rates.
Each variation to withholding is considered on its merits with the ATO.
If the variation letter did state ‘bonus’ then the bonus can be taxed at the specified rate.
Keen on method B? Please visit the following link
https://www.ato.gov.au/Rates/Schedule-5—Tax-table-for-back-payments-commissions-bonuses-and-similar-payments/