I’ve noticed a lot of confusion and frustration about taxes on military bonuses. That’s not surprising, because it IS confusing, but it doesn’t have to be too hard to understand.
First, you have to have a firm grasp on how income taxes work. If you are not sure, then read How Income Taxes Work, and ask questions. Feeling good about regular taxes? Great.
Here’s the magic thing about taxes on military bonuses: adding a bonus just changes the numbers. Everything else is the same. Your income number goes up, and your withholding number goes up because you’ve had taxes withheld on the bonus.
Here’s an example of a servicemember who gets a $10,000 bonus that has $2,500 in taxes withheld from the payment. Everything else remains the same, except his income is higher, increasing his taxes, and his withheld amount is higher.
In this sample, the taxpayer had $2,500 withheld from the bonus payment, but had an additional $1,277 in their tax refund, so they really only paid $1,223 in taxes on that $10,000 payment. Obviously, every single tax situation will be different, but this gives you a rough idea how it works.
The IRS requires that the Defense Finance and Accounting Service (DFAS) withhold 25% of all bonus payments. Just like all other tax withholding, the taxes taken out could be too much or too little. Thankfully, they’re usually too much, and they get returned to you as part of the overpayment/refund when you file your tax return. If the taxes taken out of the bonus are too little, you may owe additional tax when you file your tax return.
There are a couple of things to think about:
Bonuses in a Combat Zone
If you are able to receive your bonus while you are located in a Combat Zone Tax Exempt area, then you won’t owe federal income taxes on that money. Schwing!
Bonuses Saved for Retirement
Bonuses can be put into retirement savings accounts such as the Thrift Savings Plan (TSP) or an Individual Retirement Arrangement (IRA). If you put it into a Roth account, it won’t give you any tax benefit now, but it will grow tax-free and distributions later will be tax free. If you use a traditional account, you won’t be taxed on that money now but future distributions will be taxable.
You Can Save More If You’re In A Combat Zone
If you are in a Combat Zone Tax Exempt area, you can contribute above the usual limit. Instead of $18,000 for the year, you can contribute up to $53,000 (2016). There are some tricky rules about contributions, because amounts that exceed the $18,000 limit must be made into traditional accounts. Get some help if you’re a super-saver who is going to exceed the $18,000 limit with tax-exempt funds.
If you have questions about other aspects of military enlistment and re-enlistment bonuses, see Ryan’s great post at The Military Wallet: Enlistment and Reenlistment Bonus Guide – Everything You Need to Know about Bonuses.
Still confused about taxes on military bonuses? Ask questions in the comments. I’ll answer them for you, plus update this post to make it more clear.
For more information on military tax issues, you might enjoy: