Employee pay 101: What’s taxed and what’s not?
One of the perks of working for someone else is that you may receive a bump in pay from sources other than your regular salary. You’ll generally owe income tax on bonuses, stock compensation, and certain gifts from your employer.
But other benefits, such as tuition assistance and expenses your employer reimbursed, won’t be included in your ordinary income. Here’s what to know.
What’s considered taxable income?
Here’s a breakdown of extra income that’s taxable and what you might owe:
Bonuses
Bonuses are considered supplemental pay, which is money you receive in addition to regular wages. This type of income is usually taxed at a higher rate, which “can take the wind out of your sails,” said Justin Pritchard, a certified financial planner. “You might hear that you’re getting a certain amount, but when the funds hit your bank account, you could be disappointed.”
For federal taxes, your employer can either withhold a flat percentage on your bonus or combine it with regular wages. On bonuses under $1 million, the employer usually withholds 22%, Pritchard said. But your tax rate is higher if you’re fortunate enough to receive a larger bonus. And if your bonus is subject to state taxes, too, that withholding rate depends on your state laws.
Talk about the tax withholding method with your employer.
“If you get your bonus paid separately from your wages, the payment may qualify for the flat-rate approach, which could result in a lower withholding rate,” Pritchard said.
Otherwise, you could lower your tax bill by making pre-tax contributions to your retirement plan or health savings account.
Gifts from your employer
If you received a token of appreciation for all your hard work during the craziness of the last year, you might owe taxes on what you received. Gifts from an employer can get complicated, so “it’s safest to assume that anything of significant value is taxable,” Pritchard said.
Generally, employers can give you small items — think simple birthday parties, occasional lunch outings, and Secret Santa gifts — without reporting it as compensation.
But be careful with cash or valuable items, like gift cards or a vacation package. These could result in taxes, Pritchard said.
Stock compensation
Some companies include stock compensation as part of an employee’s benefits package or as a reward for a job well done. One form of stock compensation is the restricted stock award, where the company transfers shares to the employee and subjects those shares to a vesting schedule.
When the stock vests, your employer can deduct the fair market value, add it to your W-2 wages, and withhold applicable taxes. If you decide to make an irrevocable election within 30 days after receiving the stock, the shares become taxable at that point—without having to wait for the shares to vest. This could help you avoid a large tax bill if you expect the value of the stock to increase.
There are other types of stock compensation and each is treated differently for tax purposes, so it might be best to check with a tax professional before cashing in your shares.
What’s not taxed?
Some forms of pay may appear on your pay stubs and W-2, but they should be excluded from your taxable income. Here are some examples:
Employer-sponsored education payments
Through 2025, employers can contribute up to $5,250 toward an employee’s tuition costs or student loan payments, without counting toward the employee’s gross taxable income. That means neither the company nor the employee will pay taxes on the benefit.
Your human resources department will know whether your company offers this perk and how to get you signed up.
“If your employer does not offer anything, find out if your state offers a tax break on contributions to a 529 college savings program,” Pritchard said. “The benefit might be small, but it’s better than nothing.”
Business expense reimbursement
If you had to pay for travel expenses, office supplies, or another legitimate business expense that your employer reimbursed, these shouldn’t be added to your taxable income, either.
“However, it’s critical to verify that your employer codes the payments correctly,” Pritchard said. “If your employer makes a mistake, you might end up paying income tax and payroll taxes, and the reimbursement will fall short of what you spent.”
Read more information and tips in our Taxes section
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