SARS thanks you for their 13th cheque
Why bonuses are taxed so savagely
EVERY YEAR at around this time, I get queries from people asking why SARS has taken such a massive bite out of their hard-earned bonus.
Such queries are understandable, as the following simplified example indicates:
- Employee X (who is under the age of 65) receives an annual salary of R180 000 (i.e. R15 000 per month). No other allowances are received, and the employee is not a member of a medical aid or retirement fund.
- On each monthly payslip, PAYE of R1 390.50 is deducted based on the application of the tax tables, leaving the employee with ‘take-home’ pay of R13 609.50. (UIF is ignored for the purposes of this example.)
- The employee is entitled to a year-end bonus, or ‘13th cheque’ equivalent to one month’s salary.
- Payroll has informed the employee that bonuses are taxed, which the employee reluctantly accepts. Still, an extra R13 609.50 will certainly solve a few cash flow problems that have accumulated through the year, leaving enough to get the kids something for Christmas.
- The employee is thus shocked to find that their total PAYE deducted from their December salary was not R2 781.00 as initially anticipated, but R4 090.50! The tax on the bonus was therefore a whopping amount of R2 700.00!
- With the Christmas presents having already been bought at the Black Fri-day sales (paid for by credit card), this crestfallen employee now finds themselves R1 390.50 short in their December budget.
To understand why Employee X has suddenly found themselves in this predicament, we need to understand how the tax tables (presented below) work in practice.
In this particular example, the employee’s normal annual salary (excluding their 13th cheque) of R180 000 puts them in the first ‘tax band’, which is applicable to taxable income from R1 to R216 200 per annum.
The applicable tax rate is 18%, which means that the annual tax liability (before rebates) is R32 400. However, the employee is entitled to the ‘primary’ rebate of R15 714 thus reducing their annual tax liability to R16 686. Payroll takes this amount and divides it by 12 months to get to the R1 390.50 that the employee sees on their payslip.
The employee receives their 13th cheque in December. This amount of R15 000 needs to be added to their normal annual salary, bringing the total taxable income up to R195 000. This is still within the first tax band, so by applying the same calculations (i.e. R195 000 x 18%, less the primary rebate) we get a tax liability of R19 386.
Payroll then takes this new tax liability (R19 386), subtracts the tax amount that would be deducted on their normal salary (R16 686), leaving a shortfall of R2 700. This is the amount of PAYE that is then subtracted from the 13th cheque.
This example illustrates the difference between the ‘average’ rate of tax, and the ‘marginal’ tax rate.
- Your ‘average’ tax rate is based on the amount of tax actually paid, expressed as a percentage of one’s taxable income. In this case, tax of R16 686 as a percentage of taxable income of R180 000 gives the employee an average rate of 9.27%.
- Your ‘marginal’ tax rate is based on the percentage of tax that any additional income will be charged at, and depends on which tax band you fall into. In this example, the employee falls into the first tax band, which means that the tax liability on their additional income (i.e. the bonus) is 18%.
The reason for the discrepancy between the two rates is down to the rebates. For example, taxpayers under the age of 65 receive a ‘primary rebate’ of R15 714. What this effectively means is that the first R87 300 of annual taxable income is tax-free.
This tax-free amount is known as the ‘tax threshold’. Once you go above the threshold, you start paying tax. If (for example) your annual earnings are R87 301, you are effectively R1 over the tax threshold and your tax liability will thus be 18 cents (being 18% of the R1 earned over the tax threshold).
However, this simple example doesn’t illustrate what happens to an employee whose earnings are near the top of their current band.
For example, someone earning R18 000 per month (R216 000 per annum) is at the upper end of the 18% tax band would have a normal monthly tax bill of R1 930.50—but a 13th cheque of one month’s salary will push them into the 26% tax band.
In this case, R200 of such bonus will be taxed at 18%, while the balance (which spills over into the next band) will be taxed at 26%, resulting in a hefty R4 664.00 being hacked out of their bonus!
How to mitigate the tax burden
One option is to simply not declare the bonus payment. In fact, some employers are genuinely under the misconception that a bonus is more of a ‘gift’ than a salary—particularly in cases where such bonuses are not guaranteed.
However, a SARS auditor would only need to ask a single question of the employer: Would this person have received the payment if it weren’t for the relationship between the taxpayer and the employer? The obvious answer would be ‘no’, and it would be a slam-dunk for SARS to hit the employer with interest, penalties, and possible criminal sanction.
So, here’s the bad news: If you get a bonus, it’s part of your remuneration and is thus subject to tax. How then does one soften the blow?
- You can forego the bonus to avoid the pain of paying tax thereon, but that would be blatantly stupid. After all, even if you are in the top tax bracket where your marginal tax rate is 45%, taking home 55% of something is still better than 100% of nothing!
- The other option is to ask your employer to calculate the tax on the bonus, divided it by 12, and deduct the additional amount each month. However, this is normally only an option if such bonus is guaranteed. Besides, doing it this way means that you’re effectively paying the tax thereon before it is legally due. Now I don’t know about you, but I’m certainly not in the business of providing interest-free financing to SARS!
- Alternatively, since this is a bonus after all, you could ask your payroll department (or your tax practitioner) to calculate the PAYE to be deducted, and simply brace yourself and take it on the chin. Knowing in advance what the take-home portion will be is better than being shocked when you get your payslip a week or two before Christmas.
- Finally, the best option is to work out what the PAYE will be on the bonus, divide the amount by 12, and stash this money into a savings account (or your access bond, if you have one). You can then pull these funds out when you actually get your bonus, giving you a sense of getting a ‘full’ 13th cheque.
In the latter case, while the interest earned (or saved) is not likely to be astronomical, the savings habit will be far more valuable—and if you can do this and then decide not to withdraw the funds come bonus time, the build-up of savings (or the reduction in your home loan) will end up making a massive difference to your financial future.
Even better—if you still have sufficient allowance available for deducting retirement fund contributions, consider shoving this additional amount into your retirement savings. This will not only enhance your future retirement income; it will also give you a second ‘mini-bonus’ each year when SARS pays out your tax refund!
Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Tax Breaks and Personal Finance.