Why Are Bonuses Considered Earned Income and Taxed?

Many are puzzled by the fact that bonuses, just like other earned income, are subject to taxation. This article will explore the reasons behind this, including the historical context, the IRS' perspective, and the implications of exempting bonuses from taxes.

Understanding the Governance of Bonuses as Earned Income

Back in 1913, Congress enacted the income tax due to the realization that user fees, taxes on licenses, and other “necessities” didn’t generate sufficient revenue for the federal government. The idea was to create a systematic approach to raising funds for the government’s operations. Initially, the income tax covered all earned income, and bonuses were included within this category.

Historical Context and the Inclusion of Bonuses

The tax system was designed to treat all forms of income equally, meaning bonuses, no matter the reason for their distribution, fall under the same tax regulations as regular salary or wages. This is because bonuses are essentially additional compensation that employees earn through their employment, which aligns with the legal definition of “income.”

IRS Perspective and Security Pay

The IRS views any additional form of compensation as earned income, even if it is severance pay or security pay. These payments are made due to an employment termination or other circumstances. The IRS is convinced that these amounts are earned, hence they are subject to tax. The rationale behind taxing such payments is to maintain and protect the tax base, ensuring that all sources of income are adequately and uniformly taxed.

Other Examples of Taxed Income

It's important to note that taxed income does not just include bonuses; it encompasses a variety of sources, including gambling winnings, second job earnings, and illegal income. This helps to provide a comprehensive approach to tax collection, deterring potential VAT evasion and ensuring fair distribution of tax revenue.

Implications of Taxing Bonuses

If bonuses were not taxed, employees might become inclined to rely heavily on bonuses, which could lead to a disparity in income across the working population. This could result in a smaller portion of income being subject to tax, potentially leading to reduced government revenue and increased financial disparity.

Corporate Tax Strategies and the Impact of Bonus Taxation

Were bonuses to be tax-free, companies might opt to pay most of an employee’s compensation through bonuses to avoid the need for a regular salary subject to tax. This could distort the balance between different forms of income and undermine the fairness of the tax system. Taxing bonuses ensures that all forms of income are subject to the same tax rate, promoting fair income distribution and bridging the gap between taxable and tax-exempt sources of income.

Final Thoughts

In conclusion, the taxation of bonuses, just like all other forms of earned income, is a crucial aspect of the tax system. It aims to maintain a fair and comprehensive financial system, ensuring that all sources of income are subject to tax. By subjecting bonuses to taxation, the government can better support its operations and promote a more equitable distribution of wealth and resources.