Taking a bite out of the year-end bonus

Taking a bite out of the year-end bonus

Tax on annual bonuses remains a great source of misunderstanding. We have had a number of unhappy/upset payroll clients approaching us recently because they feel too much tax has been deducted from their annual bonus! This newsletter explains why this appears to be the case and what can be done to address the issue.

Many organisations still elect to pay out a bonus or 13th cheque at this time of the year. However, the joy of receiving such a payment can be short-lived when the employee realises that a substantial bite from this additional payment is taken by SARS, especially when comparing that bite with the one taken from their normal monthly salary.

Individual income tax rates in South Africa are structured on a “progressive” basis, which means that the more you earn, the more you pay. Tax is calculated in bands and, as you move through the various tax bands, the amount of tax paid on each additional rand earned increases. The percentage applicable to the highest band against which tax is charged is known as the “marginal rate”. Furthermore, although most people are paid monthly, and therefore have tax deducted monthly, tax is actually calculated on annual earnings.

This can best be explained by way of a simple example; take Zandile, who is paid R14,500 per month:

Monthly remuneration R  14,500.00
Annual remuneration (without bonus) R 174,000.00 (falls within 18% income tax band)
Monthly tax / PAYE R 1,505.25

If Zandile is awarded a bonus, or receives a 13th cheque, of R14,500, her total pay for the tax year will increase to R188,500. This takes her into the higher (26%) income tax band, and results in the following tax/ deduction in the month the bonus / 13th cheque is paid:

Monthly remuneration R  14,500.00
Bonus R  14,500.00
Annual remuneration R 188,500.00 (moves Zandile into the 26% income tax band)
Tax / PAYE for this month  R 4,643.25

With the payment of the bonus / 13th cheque, Zandile’s tax bill has increased to R4,643.25 for the month in which she receives her bonus, an increase of R3,138 over  the R1,505.25 she has become used to each month!

The only way in which this blow can be softened is to spread the tax on the bonus over the full year but this will only work if the bonus / 13th cheque is guaranteed each year (otherwise there is a risk that tax will be overpaid).  [Also, please note that the calculation might be further complicated if the basic salary changes during the year.]

We do hope that this will explain the size of the bite taken by SARS from a bonus or 13th cheque.