Why bonuses are taxed so savagely
EVERY YEAR at around this time, I get queries from people asking why SARS has taken such a massive bite out of their hard-earned bonus.
Such queries are understandable, as the following simplified example indicates:
- Employee X (who is under the age of 65) receives an annual salary of R360 000 (i.e. R30 000 per month). No other allowances are received, and the employee is not a member of a medical aid or retirement fund.
- On each monthly payslip, PAYE of R4 783.08 (2024/25 tax tables) is deducted based on the application of the tax tables, leaving the employee with ‘take-home’ pay of R25 216.92. (UIF is ignored for the purposes of this example.)
- The employee is entitled to a year-end bonus, or ‘13th cheque’ equivalent to one month’s salary.
- Payroll has informed the employee that bonuses are taxed, which the employee reluctantly accepts. Still, an extra R25 216.92 will certainly solve a few cash flow problems that have accumulated through the year, leaving enough to get the kids something for Christmas.
- The employee is thus shocked to find that their total PAYE deducted from their December salary was not a (still not-inconsiderable) R9 566.16 as initially anticipated, but R13 558.08! The tax on the bonus was therefore a whopping amount of R8 775.00!
- With the Christmas presents having already been bought at the Black Friday sales (paid for by credit card), this crestfallen employee now finds themselves just shy of R4 000 short in their December budget.
What happened?
To understand why Employee X has suddenly found themselves in this predicament, we need to understand how the tax tables (2024/25, presented below) work in practice.
In this particular example, the employee’s normal annual salary (excluding their 13th cheque) of R360 000 puts them in the second ‘tax band’, which is applicable to taxable income from R237 101 to R370 500 per annum.
The applicable tax rate is R42 678 plus 26% of the amount exceeding R237 100, which means that the annual tax liability (before rebates) is R74 632. However, the employee is entitled to the ‘primary’ rebate of R17 235 thus reducing their annual tax liability to R57 397.
Payroll takes this amount and divides it by 12 months to get to the R4 783.08 that the employee sees on their payslip.
The employee receives their 13th cheque in December. This amount of R30 000 needs to be added to their normal annual salary, bringing the total taxable income up to R390 000.
This takes the employee up into the third tax band, which is applicable to taxable income from R370 501 to R512 800 per annum. The calculation in this instance is R77 362 plus 36% of the amount exceeding R370 500, less the primary rebate—this brings the total annual tax liability of R66 172.
Payroll then takes this new tax liability (R66 172), subtracts the tax amount that would be deducted on their normal salary (R57 397), leaving a shortfall of R8 775. This is the amount of PAYE that is then subtracted from the 13th cheque.
This example illustrates the difference between the ‘average’ rate of tax, and the ‘marginal’ tax rate.
- Your ‘average’ tax rate is based on the amount of tax actually paid, expressed as a percentage of one’s taxable income. In this case, tax of R57 387 as a percentage of taxable income of R360 000 gives the employee an average rate of 15.94%.
- Your ‘marginal’ tax rate is based on the percentage of tax that any additional income will be charged at, and depends on which tax band you fall into. In this example, the employee now straddles the second and third tax band, which means that part of the bonus is taxed at 26% and part of it at 31% (the actual percentage deducted from the bonus in this instance is 29.25%).
The reason for the discrepancy between the two rates is down to the rebates. For example, taxpayers under the age of 65 receive a ‘primary rebate’ of R17 235. What this effectively means is that the first R95 750 of annual taxable income is tax-free.
This tax-free amount is known as the ‘tax threshold’. Once you go above the threshold, you start paying tax. If (for example) your annual earnings are R95 751, you are effectively R1 over the tax threshold and your tax liability will thus be 18 cents (being 18% of the R1 earned over the tax threshold).
How to mitigate the tax burden
One option is to simply not declare the bonus payment. In fact, some employers are genuinely under the misconception that a bonus is more of a ‘gift’ than a salary—particularly in cases where such bonuses are not guaranteed.
However, a SARS auditor would only need to ask a single question of the employer: Would this person have received the payment if it weren’t for the relationship between the taxpayer and the employer? The obvious answer would be ‘no’, and it would be a slam-dunk for SARS to hit the employer with interest, penalties, and possible criminal sanction.
So, here’s the bad news: If you get a bonus, it’s part of your remuneration and is thus subject to tax. How then does one soften the blow?
- You can forego the bonus to avoid the pain of paying tax thereon, but that would be blatantly stupid. After all, even if you are in the top tax bracket where your marginal tax rate is 45%, taking home 55% of something is still better than 100% of nothing!
- The other option is to ask your employer to calculate the tax on the bonus, divided it by 12, and deduct the additional amount each month. However, this is normally only an option if such bonus is guaranteed. Besides, doing it this way means that you’re effectively paying the tax thereon before it is legally due. Now I don’t know about you, but I’m certainly not in the business of providing interest-free financing to SARS!
- Alternatively, since this is a bonus after all, you could ask your payroll department (or your tax practitioner) to calculate the PAYE to be deducted, and simply brace yourself and take it on the chin. Knowing in advance what the take-home portion will be is better than being shocked when you get your payslip a week or two before Christmas.
- Finally, the best option is to work out what the PAYE will be on the bonus, divide the amount by 12, and stash this money into a savings account (or your access bond, if you have one). You can then pull these funds out when you actually get your bonus, giving you a sense of getting a ‘full’ 13th cheque.
In the latter case, while the interest earned (or saved) is not likely to be astronomical, the savings habit will be far more valuable—and if you can do this and then decide not to withdraw the funds come bonus time, the build-up of savings (or the reduction in your home loan) will end up making a massive difference to your financial future.
Even better—if you still have sufficient allowance available for deducting retirement fund contributions, consider shoving this additional amount into your retirement savings. This will not only enhance your future retirement income; it will also give you a second ‘mini-bonus’ each year when SARS pays out your tax refund!
Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Personal Finance and Tax Breaks.
