How to maximise the benefit of the end-of-year bonus
Getting a year-end bonus is satisfying, but paying the tax due can take the joy out of it
Does this sound familiar? You’re one of the lucky ones to get an end of year bonus, which means that, come Christmas, you hit the shops with a bang and the drinks are on you.
The hangover however, comes when you finally get your hands on your after-tax “bonus” in January. Yes, that extra payment which once promised so much, has been slashed by more than half thanks to the onerous tax treatment of bonuses.
Indeed, with top tax rates still north of 50 per cent, the benefits of a bonus are often far less than we first expect.
“People get a shock about how much tax they pay,” agrees Daryl Hanberry, tax partner at Deloitte.
But, with end-of-year bonus season fast approaching for some, is there anything that can be done to help you keep more of your cash?
How is a bonus taxed?Bonuses are taxed in the same way as other forms of PAYE income. For example, if you’re married, with one earner, and a basic salary of €60,000, a bonus of €20,000 will be taxed at a rate of 51.5 per cent, says Hanberry, leaving you with just €9,700.
And a bonus payment can really disappoint if you’re on the cusp of the higher rate – if you are used to paying tax at the lower rate, but the bonus pushes you into it. Consider someone on the lower tax rate, with a salary of €30,000. As Hanberry points out, they will pay a tax rate of 43.4 per cent on their bonus, leaving them with €5,660 out of a €10,000 payment.
Can this tax be mitigated?Unfortunately, there is not a whole lot that can be done to reduce this tax bill, as the Revenue Commissioners have become quite focused on what they deem to be “salary sacrifice” or, as Hanberry explains, sacrificing a taxable benefit for a non-taxable benefit. “Revenue has significant powers to review correspondence, and to review contract of employment; they do have the power to seek out any types of salary sacrifice arrangements,” he adds.
But there are still some options out there. The most obvious way to reduce your tax burden is to make additional voluntary contributions (AVCs), or regular contributions to your pension, up to the various age-related limits.
For example, up to the age of 30 you can get tax relief on 15 per cent of your salary that you put into your pension, rising to 20 per cent if you’re aged between 30 and 39, and so on.
“You get full income tax relief for that contribution; you won’t however get relief from PRSI or USC,” says Hanberry, adding that these pension contributions must be made by your employer so effectively, your bonus will have been put through payroll for tax purposes.
What about tax free vouchers?But it’s not all doom and gloom. If you are the beneficiary of tax-free vouchers from your employer come Christmas, for example, you may be interested to learn that October’s Finance Bill increased the amount employees can receive tax free from €250 to €500.
If you’re a higher-rate tax payer, you will save as much as €260 in tax by opting for a voucher bonus from next year.
While the change originally wasn’t going to apply until January 1st, 2016, Minister for Finance Michael Noonan said during a Dáil debate on the Finance Bill in early November that the increased amount of €500 is now effective from the date of publication of the Bill on October 20th last.
This means that, if your employer is feeling generous this year, you could enjoy up to €500 in tax free vouchers this Christmas. Known as the small-benefits exemption, the bonus is good for both employers and employees. Employees avoid PAYE, PRSI and USC, and employers don’t have to pay PRSI. The catch is that the bonus can’t be paid in cash, so employers typically opt for vouchers such as One4All or those from supermarket chains to offer their employees. The voucher can only be paid once a year.
Salary sacrifice schemesAnother option is to consider one of the various Revenue-approved salary sacrifice schemes. If you haven’t done so already, bonus time may be an opportune moment to do so.
The Tax Saver scheme, for example, allows you to cut the cost of your commute by enabling your employer to pay for an annual travel pass out of your gross salary. This means that you will get full tax savings on the cost of the pass, which effectively will cut it in half if you pay tax at the higher rate.
“It’s quite a useful tool,” says Hanberry, adding that it’s useful for employers as well, because they save on employer PRSI.
For example, an annual pass with Dublin Bus comes in at around €1,760 – but if you buy it through the Tax Saver scheme you’ll save €897.60 if you’re a higher-rate tax payer, or €545.60 if you pay tax at the lower rate.
On that basis, if you use a bonus of €2,000 to pay a Dublin Bus pass, you’ll end up with a taxable bonus of just €240 – so will lose just €120 or so to tax if you’re a higher-rate tax payer.
The same principle applies to the Bike to Work scheme, which allows you to pay for the cost of a new bike from your gross, rather than your after-tax, income. And if you’re only a fair weather cyclist, the good news is that the schemes aren’t mutually exclusive. “You can have both a bike to work and travel saver scheme as well,” notes Hanberry.
Finally, and perhaps the most lucrative, is a Revenue-approved profit sharing scheme. This allows approved employers (which include AIB, HP, Vodafone and Procter & Gamble) to give employees the option of receiving tax-free shares as an alternative to cash bonuses. While companies may not be as generous as they once were with such schemes, they’re still in use. “They’re still popular as they’re still a good means of providing value to employees,” notes Hanberry.
There are restrictions however. A cap of €12,700 on the amount that can be given tax free applies; the shares must be held in trust for at least three years; and employees will still have to pay PRSI and USC on this. It still means, however, that for employees faced with a 52 per cent charge, it can be reduced to just 11 per cent. Capital gains tax will only apply on the sales proceeds in excess of original value.