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How Are Sign-On Bonuses Taxed?

  • Jul 13
  • 9 min read

For many residents or fellows, a sign on bonus is the largest check they’ve received to date. Although it can be very exciting to receive one, it’s important to understand how much of the signing bonus you negotiated in your contract you can actually count on being able to spend.  For many physicians in our community, it can be confusing when the amount that lands in your bank account is much smaller than you expected. Questions about how sign-on bonuses are taxed, whether they're taxed differently than regular income, and whether there's anything you can do to reduce the tax burden are common among physicians in our online communities. While the tax rules surrounding sign-on bonuses are fairly straightforward, there are a few important nuances that can help you avoid surprises and plan how to make the most of this valuable part of your compensation package. Below, we’ll cover these points and more.


Disclosure/Disclaimer: Our content is for generalized educational purposes.  While we try to ensure it is accurate and updated, we cannot guarantee it. We are not formal financial, legal, or tax professionals and do not provide individualized advice specific to your situation. You should consult these as appropriate and/or do your own due diligence before making decisions based on this page. To learn more, visit our disclaimers and disclosures.


Percentage method vs aggregate method of withholding taxes on bonus payments


Background on sign-on bonus taxes


Landing your first attending position – or accepting a new job later in your career – often comes with a negotiated sign-on bonus. It can feel like a great financial boost after years of training or during a transition between jobs. Especially lately, sign on bonuses have been getting bigger as physician shortages amplify, and hospitals and practices compete to attract new talent. See average sign on bonuses by physician specialty.


Then the check arrives, and instead of seeing the full amount you negotiated, you notice that a significant portion has already disappeared due to taxes which have been withheld, potentially at a rate that is higher than the rate you're used to being taxed at.


Remember, a sign-on bonus is absolutely taxable income. However, the amount withheld when you receive the payment isn't always the same as the amount of tax you'll ultimately owe. Understanding the difference can help you avoid surprises and make smarter financial decisions.



How are sign-on bonuses taxed, and is it the same rate as your ordinary income tax?


A sign-on bonus is considered ordinary income (and thus taxable compensation) by the IRS, and is taxed just like the rest of your wages.


Your bonus is generally subject to:

  • Federal income tax

  • State and local income taxes (where applicable)

  • Social Security tax

  • Medicare tax


Your employer will report the bonus on your W-2, and it will become part of your total taxable income for the year alongside your salary.


Sign-on bonuses vs. salary income taxes


We'll discuss below how your sign-on bonus may seem like it's being taxed at a different rate than your regular paycheck because less is being deducted against it, or because the withholding rate is different, but that's not actually how the tax system works. At the end of the year, your bonus is added to your salary and any other taxable income to determine your actual total tax liability, and the taxes you overpaid or underpaid will be credited. 


The confusion comes from how employers typically withhold taxes on bonus paychecks, which can differ from the withholding on your regular paycheck.



Why does my bonus seem so heavily taxed?


Sign-on bonuses are often treated as supplemental wages, which are often subject to different federal withholding rules than regular paychecks. Rather than calculating withholding based on your W-4 elections and expected annual income, many employers use the IRS supplemental wage withholding rules when issuing bonuses, which may be a flat supplemental withholding rate or another IRS-approved method (discussed below). 


As a result, a larger percentage of your bonus may be withheld upfront than you're used to seeing on a normal paycheck, which leads to the myth that they are taxed heavier than your other income, even though it's all squared up at the end of the year.



How withholdings work with signing bonuses


There are different methods that the employer can choose to use when deciding how to withhold federal taxes on bonuses, which is what often leads to confusion on our communities. Generally speaking, sign on bonuses are still considered W2 income, even if you haven’t started working. There are two main methods to withhold federal taxes on bonuses, the percentage method and the aggregate method, and your employer will pick one of them. 



The percentage method


This is the method that most employers use for separately cut signing bonus checks, as it is the most convenient. The federal withholding tax rate for bonuses is a flat 22% tax rate, unless the bonus is > 1 million dollars, in which case the withholding rate becomes 37%. Since sign on bonuses won't be >$1M for most physicians,  a straight 22% federal tax is usually applied to the amount of the sign on bonus, regardless of what your normal income tax bracket is.  



The aggregate method


The aggregate method is used less commonly, and when it is used, it's usually because the sign on bonus is being paid alongside your salary. In the aggregate method of calculating the withholding, the employer treats your bonus as regular income and combines it with regular wages for that pay period. The withholding is calculated as though the combined amount were a single paycheck. Because the withholding calculation tables assume that this paycheck amount will continue throughout the whole year, the calculated withholding can be significantly higher than the flat supplemental rate in the percentage method depending on how you've set up your Form W-4 and your individual tax situation. This is why you may think you’re getting taxed at a higher rate on your paycheck, as you will have higher withholdings via this method in some cases. Again, remember, this will all be figured out at the end of the tax year. If you don't want them to do this, specifically inquire to see if you can be paid by the percentage method.



Withholding is not the same as your tax rate


Remember that withholding is simply a prepayment toward your eventual tax bill – it doesn't necessarily reflect the amount of tax you'll ultimately owe.


This distinction is one of the most confusing parts of receiving a sign-on bonus. Think of withholding the same way as making estimated quarterly tax payments toward your taxes throughout the year. The government wants some of the tax liability paid out throughout the year, so they ask that the estimated tax liability is withheld when the bonus is paid. Your actual tax liability is determined only at the end of the year after considering your:

  • Total annual income

  • Filing status

  • Deductions

  • Credits

  • Retirement contributions

  • Other taxable income


If too much was withheld, you may receive the difference back as part of your tax refund. If too little was withheld, you may owe additional tax when you file your return.



How sign-on bonuses are taxed: tax withholding vs your actual tax liability


Tax returns and balancing out owed taxes with what was withheld from your bonus


As we said above, the amount withheld from your sign-on bonus is only an estimate of your tax liability. When you file your tax return, the IRS looks at your total income for the year, along with your deductions, credits, retirement contributions, and other tax factors, to calculate what you actually owe. If too much was withheld from your bonus and your other income, you'll generally receive the excess as part of your tax refund. 


On the other hand, if not enough tax was withheld throughout the year, you could end up owing additional taxes.


How does withholding of a bonus work compared to normal paychecks you receive?


Every time a normal paycheck comes to you, there are a lot of things deducted from the paycheck prior to arriving at the final amount that actually deposits into your bank account. This includes things like taxes owed, your retirement contributions, insurance payments, and how much you asked to be withheld on your W4 form when you were hired based on your applicable situation (children, spousal earnings, etc.). In the case of a signing bonus paycheck that is issued separately, you likely won't have many of these things being deducted, especially because you may not have even started working yet, and therefore may not be eligible for things like health insurance or other benefits.


Related PSG resources:



Special situations to consider when thinking about taxation and your signing bonus


An important caveat to remember for residents and fellows, or for attending physicians changing states or jobs with significant changes in income


Since your actual federal income tax rate that you ultimately pay differs based on your income and deductions for the year, it may be to your advantage to get your signing bonus in a year where you are still in training. In this situation, the taxes owed on your signing bonus may be lower, since your income will be lower, therefore pushing your signing bonus income into a lower marginal tax bracket. 


Additionally, always remember that in addition to federal taxes, state and local tax rules still apply. Make sure you compare state and local taxes in your training location with those in the location you’re moving to to calculate when it’s best to receive the bonus as well.


Talk to an accountant about the nuances of all of this if you think it will make a difference in your situation.




What to do if you are told that you will get a paycheck without taxes withheld


Generally speaking, this is a bad idea, because it can become complicated for you and result in extra taxes paid by you. You should likely ask them to have it paid out as a W2 with taxes withheld. This is because if they send you a check without taxes withheld, they may be sending it to you as self-employed 1099 income, which would make you responsible for both sides of the payroll taxes. Additionally, it’s not technically correct to do it this way, as sign on bonuses are supposed to be compensation for work that is performed for that employer, even if it is future work, so they should be paying their share of the taxes. 



Be careful about under-withholding


It’s important to speak to your accountant if you think that your situation may be more complicated. The IRS does not like when you hold on to money that’s legally theirs for too long, so if you under-withhold your taxes, you could be subject to penalties. These penalties typically occur when you owe more than $1000, AND you do not pay 90% of your total owed income tax for the year as you receive it (and if you didn’t pay the taxes you owed for the prior year).



Should you spend your entire bonus immediately?


After years of residency, many physicians understandably want to celebrate with a vacation, a home purchase, or paying off debt. However, it's generally wise to wait until you understand your overall tax situation before committing every dollar. Many physicians choose to use sign-on bonuses to:

  • Build an emergency fund

  • Pay down high-interest debt

  • Fund retirement accounts (if eligible)

  • Cover relocation expenses

  • Create a cushion for estimated taxes if needed


6 smart ways physicians can use their sign-on bonuses



Conclusion


A sign-on bonus is an exciting milestone, but don't let the tax withholding catch you off guard.


Remember that the amount withheld from your bonus is not necessarily the amount you'll ultimately owe in taxes. Understanding how bonus withholding works can help you budget appropriately, avoid unnecessary stress, and make informed financial decisions during an important career transition.


If you're receiving a substantial sign-on bonus–especially alongside relocation benefits or other compensation–it may be worthwhile to review your situation with a qualified tax professional so you understand the full financial picture before spending the money.



Additional sign on bonus and contract negotiation related resources for physicians


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