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Signing bonuses and their tax implications

A signing bonus is a financial incentive that an organization or business offers a prospective employee in order to woo them to join up. It could be given in the form of a one-time major cash payment or stock options and may as well be a combination of both. 

Signing bonuses are mainly offered to highly valued candidates who are on the radar, or potential getting offers, from other companies or businesses.

In the health sector, hospitals often include a signing bonus to recruit and retain physicians, especially if they would be working in an underserved community. 

Similarly, if a hospital heard that a “hotshot” doctor or nurse was moving on from their previous position, and they wanted to entice them into pledging a new allegiance, they’d typically offer a healthy signing bonus.

Employers give signing bonuses for various reasons, but here are the most common:

- To appear as a more attractive option

In certain specialized fields (engineering, accounting and the health industry) where demand for experts is strong,  there is a very healthy competition for snatching up competent workers. 

A signing bonus would be more likely since various employers would be competing for a single employee. 

- To maintain internal salary equity

Sometimes a prospective employee’s salary expectations may exceed the limit for the particular level that they would be starting at. 

However, to get the highly-valued prospective employee to stay, the employer may pay the difference under the guise of a signing bonus. 
  
- To compensate for losses

There are cases where prospective employees experience some losses in terms of bonuses or benefits as a result of leaving their previous job. 

To make up for this, a new employer might throw in a signing bonus.

The use of incentives to attract competent workers is just about the oldest trick in the employers’ book.

As a form of appreciation for agreeing to join up with the organization, an employee may be given a major cash payment and/or stock options in addition to their basic salary, vacation, bonuses and other benefits contained in the employee contract. 

The signing bonus may be calculated based on the first-year pay. For instance, a new employee may receive up to 10% of their salary or more as a signing bonus. 

The concept of offering this incentive has become pretty common already and statistics show that as much as 76% of employers exploit this method in order to recruit new employees.

The details of compensation are often private, strictly between the organization and the new hire.

They may be discouraged from revealing the terms of their employment to coworkers. Companies may take measures like having a new hire sign a confidentiality agreement. 

This is mainly to prevent internal rancor. Previous employees who have risen through the ranks to assume the same position as the new hire may not receive the same benefits even though their job descriptions are identical. 

However, if the new hire quits after a short period of time, he may be required to return the prorated portion or even all of the signing bonus- this would be contained in the employee agreement terms.

If the need comes for you to repay the bonus because you terminated your contract earlier than the specified vesting period, you’d be returning the full bonus amount to your employer- including the amount you paid in tax

Sidebar: Some question just how effective a signing bonus is especially in cases when the new hire applied for the position on their own. One could argue they don’t need an incentive if they wanted the position in the first place.

Signing bonuses may come across as an incredible advantage or gain though there are disadvantages.

As a result of the money being taxed at the recipient's marginal tax rate, a significant portion would be going to the state and federal government.

For instance, for a new hire who receives a signing bonus of $20,000 with the federal tax bracket standing at 22%, $4,400 goes for taxes, and with the state also taking a share, the $15,600 would be further eroded.

Even though you still received the bonus in full, a portion of the signing bonus was paid to you, and a portion went to the government in the form of taxation.

The steps for requesting a tax refund paid on your signing bonus depends on the amount of taxes paid and when you paid the tax back.

- Bonus Payback in the Same Year

Overpayments are regarded as “paid upon receipt” and must reflect in the employee's “income upon receipt” in the year it was received. If the signing bonus is repaid the same year as it was received, the employee need only pay the net amount. The employer can then receive the state and federal tax paid on that bonus back from the government. 

Example: 
If you were paid a bonus of $20K in 2020 for starting a new position and then left that position in 2020. The tax associated with the $20K is $5K. When you repay your employer during 2020, you would pay back the net $15K in bonus and your employer would reflect the payback in your 2020 W-2.

- Bonus Payback in a Different Year

Paying a bonus back in a year other than the year you received it is typically more complicated. As always, since overpayments are regarded as paid upon receipt, they must reflect in the employee’s income upon receipt as well.

Following our example above, you’ll need to pay back the gross amount of the bonus ($20K) instead of the net ($15K) to your employer. 

Generally, the employer will not amend their payroll to reflect the payback and to request a refund of state and federal income tax paid in the prior year. However, the employee can opt to file a claim for a deduction on their personal tax return for the tax they paid.

Note: If the bonus was $3,000 or less, the IRS does not allow you to take a credit against your taxes for the year of payback. If this is your story, you should show your employer this IRS guideline and then repay after you have received the tax amount.  

If the bonus exceeded $3,000, then under normal circumstances, you can claim a credit for federal income tax paid (you cannot request a credit for social security or medicare tax paid).  This is known as a Section 1314 Claim of Right.  You must have a reasonable expectation that you had an unrestricted right to the money at the time you received it. If you knew you were going to quit within the bonus vesting period, then you do not qualify for the credit. If you had no idea that you would be leaving within the vesting period then you can claim the credit- just make sure you document this case.

Make sure you report on your return properly.

Let’s say you earned a signing bonus in 2019 and you decide to leave your job and they require full repayment of your bonus in 2020.  When filing your 2020 taxes in 2021, you would re-compute your 2019 taxes without the bonus as part of your income.

Take the difference in your tax liability between your originally filed 2019 return and the re-computed 2019 return without the bonus and report the difference as a refundable credit on your 2020 taxes. 

Note: Some states will allow a similar credit for taxes paid and are calculated in the same manner.

As medical professionals, sign-on bonuses can be attractive when starting a new position. However, it’s important to only accept the offer if you’re in it for longer than the vesting period of the bonus. If you find yourself ready to leave and you need to repay the bonus, you do have options to get your federal and state tax paid back.  Make your decision with care, taking into account everything we’ve mentioned above.  

As always, please reach out if you’re concerned, or need help figuring out what your best option might be.