Definition
The term signing bonus refers to a lump sum payment made to a new employee, which is used as an incentive to accept an offer of employment. Companies will offer sign on bonuses to compensate an employee for the accrued benefits they lost at their prior employer.
Explanation
Also known as a sign on bonus, a signing bonus is offer to prospective employees to entice them into accepting an open position. Sign on bonuses are an attractive option for employers, since it is a one-time payment and does not affect their long-term ongoing labor budget. While the exact amount offered will vary by industry, it is commonplace for signing bonuses to be five to ten percent of the base salary offer. For example, a professional that is offered a base salary of $100,000 might also be offered a sign on bonus between $5,000 and $10,000.
This type of bonus is usually paid in one lump sum and can include a combination of both cash as well as common stocks. The sign on bonus might also come with contingencies. For example, the individual accepting the offer might be required to stay with the company for a certain amount of time or return part, or all, of the bonus.
The Internal Revenue Service (IRS) categorizes sign on bonuses as supplemental wages, which is compensation paid in excess of an employee's regular wages. As such, there are two ways of taxing this money:
Percentage Method: this is a flat rate of 25%, which means that all supplemental wages are taxed at this rate. For example, an individual receiving a $10,000 sign on bonus would have $2,500 withheld in federal income tax. This is the easiest method for employers to institute.
Aggregate Method: using this approach, the sign on bonus is added to the employee's regular paycheck. The amount of withholding is based on the IRS's normal tax tables. The incremental amount withheld for the signing bonus would be the difference between the employee's "normal" withholding and the taxes owed calculated using the aggregate method.
Note: If the bonus amount exceeds $1,000,000, the first $1,000,000 is taxed at 25%, which means $250,000 is withheld. Amounts in excess of $1,000,000 are then taxed at the maximum federal income tax rate in effect, which is currently 39.6%.
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